Your son is not allowed to claim the AOC , on his return, because he is (or can be) a dependent*. If you're not eligible, because of your income, then nobody gets the AOC.
" I was expecting to mark a portion ($4000) of the 529 profits taxable to get the higher value of the credit".
That is not necessary, you have enough expenses to claim both the AOC and claim the 529 earnings as tax free (and none of the scholarship is taxable either). You can count the $1500 computer against the 529, freeing up tuition for the AOC .
"The problem is that the 1098-T box 5 number ($5k) is being calculated (incorrectly) as taxable". That's because you're not correctly entering the offsetting expenses.
*If the student actually has a tax liability, there is a provision to allow him to claim the non-refundable portion of the AOC. But then the parent must forgo claiming the student as a dependent, and the $500 other dependent credit. The student must still indicate that he can be claimed as a dependent, on his return. A full time, unmarried student, under age 24, is only eligible for the refundable portion of the American Opportunity Credit if more than half his support comes from his earned income.
