Qualified billed expenses exceed the scholarships received on 1098t, why does Turbo Tax say the scholarships are taxable for my son?

[Carl]

The only qualified education expenses are tuition, books, and lab fees. That's it. Any amount of scholarship/grant money over the total of those three qualified education expenses are taxable income to the student. Additionally, that excess is taxed at the parent's highest tax rate if it is higher than the student's highest tax rate. (It usually is).

It's also important to work through the education section of the program the way the program is designed and intended to be used. Especially if there are 529 distributions involved here.

After you enter the 1098-T information the program will ask for those things (scholarships/grants and expenses) that were not included on the 1098-T. So if one is not careful it's quite easy to "double" your scholarship/grant income without realizing it, causing the total scholarships/grants received to be doubled - thus exceeding the qualified expenses resulting in taxable scholarship/grant income for the student.

[Hal_Al]

TurboTax assumes you will claim a Tuition credit, if you are eligible. So it reduces the amount of scholarship  used for qualified expenses. 

Since the tuition credit is more generous to the parents than any tax the student may have to pay,  that is the best way to file.

If you some reason, you are not eligible for the tuition credit, or do not want to claim it;

Go through the education section again. When you get to the screen that says “Here’s your Education Summary”.  Click edit next to “Education Information”. When you get to the screen titled “Amount Used to Calculate Education Deduction or Credit”, verify the amount you want to use or change it.

_________________________________________________________________________________

This is essentially  a tax “loophole”. The student reports all his scholarship, up to the amount needed to claim the American opportunity credit, 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 school’s billing statement specifically shows the scholarships being applied to tuition or if the conditions of the grant are that it be used to pay for qualified expenses.

Using an example: Student has $10,000 in box 5 of the 1098-T and $8000 in box 2. 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.