But on the federal taxes, (I can't speak for state), here's how things are applied.
Scholarships/grants are applied to "qualified" education expenses first. (room and board is not a qualified education expense)
Once scholarships/grants are exhausted, then if there is an "qualified" expenses left to be paid, Coverdell/529 plan money (reported on 1099-Q) is applied "first" to the remaining qualified education expenses.
If there is any Coverdell/529 monies left, it is applied to the "authorized" unqualified expenses - namely room an board.
If scholarships/grants exceed "qualified" expenses, the excess is taxed. Scholarships/grants can not be applied to anything outside of the qualified education expenses. The only qualified education expenses are tuition, books, and lab fees. That's it. Here's a scenario.
Tuition, books, lab fees billed to student for $5000
Room and board billed at $5000
Student receives $6000 in scholarships/grants
Student receives $3000 from a Coverdell/529 plan reported on a 1099-Q
IN the end, $1000 of the scholarship/grant money is taxed
$3000 of the 529 plan is applied to room and board and is NOT taxed.
The remaining $2000 for room and board is paid by the student, because the student has a part time job and the student used that money the student earned to pay it with. So in addition to the $1000 taxable scholarships money, the student will also be taxed on the $2000 they paid for room and board.
parents still qualify to claim the student as a dependent, since the student DID NOT provide MORE than 50% of the STUDENT's support.
So parent's claim student as dependent, and student will file tax return, claim all scholarships, grants, 529/Coverdell monies, the 1099-Q, the 1099-T, and the student will pay taxes on the excess scholarship money (and excess 1099-Q money if there is any excess).
