There is a loophole available for you to claim a tuition credit*, even though her expenses were covered by scholarships and 529 plans.
Yes, you should remove the 1099-Q from her return. You can do that because it will be fully covered by educational expenses.
Yes, she is required to file a return (because of the unemployment, #2 in the filing requirements previously listed above)
She had $9374 in expenses. We assign $3616 of those to the 529 distribution making it tax free (so don't report it). We assign $4000 of expenses to the AOTC, allowing you to claim that. That leaves $1758 to be covered by the scholarship. That means she has $5117 of taxable scholarship to report (6875 – 1758 = 5117).
Scholarship income is treated as earned income for purposes of calculating a dependent’s standard deduction. So, effectively, none of the scholarship will actually get taxed (but the unemployment will)
The simplest thing to do is enter a 1098-T with box 1 blank and $5117 in box 5. Enter no other numbers. It's OK to change the numbers from the actual 1098-T. Lying to TurboTax to get it to do what you want does not constitute lying to the IRS.
It's that simple.
"I can claim the student as a dependent but I'm open to NOT claiming her if that helps correct my earlier mistakes".
No, that's not allowed. Or more specifically, she is not allowed to claim herself or the tuition credit because she CAN be claimed as a dependent.
*This is not some sinister scheme. "Everybody" is doing it. From the 2019 form 1040 instructions (pg 95): “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, line 18c, and IRS.gov/EdCredit. Page 16 of PUB 970 (2019) actually has examples of how to do the “loop hole”.
