Thank you for the responses, and I appreciate the point about not matching in the computers. For what it's worth, I think the problem here is that there are three types of compensation a student could receive from a school--
1) a scholarship -- which is essentially just a discount off the price of tuition, reported on 1098-T and not taxable
2) wages-- where the student is employed by the school and paid an hourly wage (working at the library for example), which is reported on w-2
3) a stipend-- where the student receives a sum in exchange for "teaching, research, or other services". This is a situation where, for example, a student might agree to TA a class and get $500 for it. It's not a scholarship in part because the student isn't require to use the cash to reduce tuition. It's not wage income because the college is not treating undergraduates being TAs for a class as a job or the student as an employee (and to me the IRS in topic 421 seems to be acknowledging as much).
It is clearly taxable. I think it could be reported as "other income" (like an honorarium) but what's interesting is if you follow the IRS instructions then the student will get the benefit of the personal exemption and may not owe tax on it, but if it's treated as other income they they are more likely to owe tax on it (but in either case it SE taxes would not apply).
It's possible I am wrong and the college should be reporting it as w-2 income, or the student should be reporting it as other income-- sort of depends whether you think tax topic 421 is saying "here's what to do if your school gives you the wrong tax info form" or "here's what to do for stipends, which are taxable even though they aren't w-2 income". And the question of what makes the most sense for future engagement with the IRS is another question...
