From your scenario, the student will be taxed on the EARNIINGS on 4426 of the distribution.
There will be no penalty tax since the distribution was not completely used because of a scholarship.
You can enter the student as your dependent on your return, then the 1099-Q's (both) and then the 1098-T so that the TurboTax program can do the math. YOUR TurboTax program will tell you how much the student needs to claim. When you click "Maximize My Tax Break" for your return, your TurboTax program should take the 4,000 expense and give you the American Opportunity Tax Credit.
If you want to make the adjusted entries yourself, you would need to figure the taxable portion of the 12,000 distribution.
The formula is earnings (Box 2) times (expenses left) divided by distribution
You don't give the box 2 amounts from the 1099-Q
Box 2 times 7,574 divided by 12,000.
That will be the dollar amount the student will need to claim as other income. It should land on the student's Schedule 1 line 8.
IRS Pub 970
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