Q. what i'm getting from this is that the $1485 will be taxed as income?
A. No. $901 is taxed as income, on the first pass.
Q. the way i understand the pell grant is that it is to be used for qualifying expenses...books, tuition, etc ...so it doesn't seem as thought i could claim this credit?
A. No. Pell grants are not restricted. "Under current law, a student may choose whether to allocate his Pell Grant (and many other scholarships) to tuition, fees, and course related materials or to living expenses when filing a tax return" (Reference: https://www.irs.gov/pub/irs-utl/Pell%20AOTC%204%20pager.pdf)
From the form 1040 instructions: “You may be able to increase an education credit if the student chooses to include all or part of a Pell grant or certain other scholarships or fellowships in income".
So, she could claim $1973 as income and you could claim a reduced credit. If my math is correct, 1973 - 901 = $1072 is the amount the credit would be based on. The credit is 100% of the first $2000, so the credit would be $1072. The AOC is limited to being claimed 4 times and can only be claimed by undergrad students. Some parents might save claiming it for later years to get $2500 instead.
