The people at the IRS told you wrong. You do not HAVE TO reduce the box 1 amount by the box 5 amount.
Just enter the the 1098-T with $5500 in box 1 and box 5 blank.
The Tuition and Fees deduction is limited to $4000 (for some income levels $2000). But TT will handle that.
If your student had $10K of other income and did not report the $5000 of non qualified scholarship, as income, you are correct he needs to also file an amended return. It is not reported as "other income". It is reported as SCH on line 1 of form 1040. As such, it is earned income and will increase his standard deduction.
