Be sure you have it straight. Based on your description, the school shoulda but $40,000 in box 1, if they put $10K in box 5. Or, they shoulda put $30K in box 1 and 0 in box 5 (since it was a discount/tuition waiver rather than an actual scholarship).
Assuming you are correct, The 1098-T is only an informational document. The numbers on it are not required to be entered onto your tax return.
However receipt of a 1098-T frequently means you are either eligible for a tuition credit or possibly your student has taxable scholarship income. If you claim the tuition credit, you do need to report that you got one or that you qualify for an exception (the TurboTax interview will handle this)
You claim the tuition credit, or report scholarship income, based on your own financial records, not the 1098-T. In the 1098-T screen, click on the link "What if this is not what I paid the school" underneath box 1. You will then be able to enter the actual amounts paid ($40K in your case).
You can just not report the 1099-Q, at all, if your student-beneficiary has sufficient educational expenses, including room & board (even if he lives at home) to cover the distribution. When the box 1 amount on form 1099-Q is fully covered by expenses, TurboTax will enter nothing about the 1099-Q on the actual tax forms. But, it will prepare a 1099-Q worksheet for your records. You would still have to do the math to see if there were enough expenses left over for you to claim the tuition credit. You also cannot count expenses that were paid by tax free scholarships. You cannot double dip!
On form 1099-Q, instructions to the recipient reads: "Nontaxable distributions from CESAs and QTPs are not required to be reported on your income tax return. You must determine the taxability of any distribution."
