You say "So not reporting 1099-Q" then you say "I entered the 1099-Q information, with Gross distribution of $8000 as I am the recipient". Don't enter the 1099-Q, as it is fully covered by room and board and is not relevant to the education credit and scholarship. Entering it will complicate the process.
Question 1: It is also asking for Rooms and Board . Do I need to enter what was paid by 529 distribution? If I don't my taxes due goes up.
Answer 1: Yes, if you enter the 1099-Q. No, if you don't.
Question 2: My dependent has W2 of about 2500 with No with holding and 1098-T has extra 1000 (Box 5 > Box 1). Does she needs to file her own taxes but knowing that she would be claimed as dependent on mine?
Answer 2: Technically, no. $3500 total income is less than the $15,750 filing requirement.
You don't qualify for the education credit because you have no net qualifying expenses. All your expenses were covered by tax free scholarship.
But, there is a tax “loop hole” available to claim an education credit, for the parents of students on scholarship. The student reports all his scholarship, up to the amount needed to claim the American Opportunity Credit (AOC), as income on his return. That way, the parents (or himself, if he is not a dependent) can claim the tuition credit on their return. They can do this because that much tuition was no longer paid by "tax free" scholarship. You cannot do this if the conditions of the grant are that it be used to pay for qualified expenses (I don't think the Florida program is so restricted, but don't know that for a fact).
Using an example: Student has $10,000 in box 5 of the 1098-T and $8000 in box 1. At first glance he/she has $2000 of taxable income and nobody can claim the American opportunity credit. But if she reports $6000 as income on her return, the parents can claim $4000 of qualified expenses on their return.
Books and computers are also qualifying expenses for the AOC. So, extending the example, the student had another $1000 in expenses for those course materials, paid out of pocket. She would only need to report $5000 of taxable scholarship income, instead of $6000.
The IRS actually encourages use of this technique. From the form 1040 instructions: “You may be able to increase an education credit if the student chooses to include all or part of a Pell grant or certain other scholarships or fellowships in income. For more information, see Pub. 970, the instructions for Form 1040 and IRS.gov/EdCredit". PUB 970 even has examples of how to do the “loop hole”.
