Q. She has no other income from work or any other source, but her 1098-T box 5 was greater than box 1. The difference between 5 and 1 is somewhere between $4 and $6k. The reason I don't know the difference is because I don't understand what box 4 has to do with it. I'm wondering if my daughter needs to file or not?
A. No. $6000 is less than the $12,950 threshold.
Q. At the same time I'm worried about not filing and having it be a problem later when we apply for financial aid for 24-25 school year. Is there any harm in filing it even if she owes nothing?
A. No. It's a common situation for FAFSA. In, particular, you may want to have her file to document the reporting of the scholarship income if the parent's uses the "loop hole".
Q. I don't think the AOTC will help us?
A. If your income is too high (>$180K Married Filing Jointly), you are not eligible for the AOTC. If your income is too low, 40% ($1000) is refundable (you get it even if you have no tax liability).
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There is a tax “loop hole” available. 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 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 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.
