"we paid" doesn't matter. Only "paid", whether paid by you ("we"), the 529 plan, scholarships, loans or the student, friends or relatives. The restricted scholarship does matter.
Q. We can claim $4,000 in AOTC expenses, even though we ourselves only paid $2,943 in total expenses, only $1,574 of which were QEE?
A. Yes. $4,000+ of tuition was paid (in addition to the $4895 paid by the restricted scholarship). So, that's $4000 that can be allocated to the AOTC and unallocated from the tax free scholarship.
Q. We paid only $1,369 of the $6,341 charged for room and board, but we can still allocate the full $6,341 charge to our $4,000 (529) distribution?
A. Yes. Again, it doesn't matter how it was paid, just that it was paid. You're only allocating $4000 of the R&B to the 529 distribution. The other $2341 isn't allocated anywhere.
Q. – Re: “$5,361 available tuition expense” – If our $4,895 restricted scholarship covers 100% of the actual tuition charge (with only $790 fees + $784 books in QEE remaining) can we really treat $1,631 as tuition/QEE?
A. I'm not following those numbers. You said there was $10,526 in box 1 of the 1098-T. Box 1 only contains tuition and qualified fees. It is not supposed to contain any R&B. That's why I used the whole box 1 amount as QEE. It's possible that the school made a mistake and included R&B in box 1, but it extremely unlikely (schools made that mistake in the early days of the 1098-T, not so much anymore).
Q. But it’s okay to use that $10,526 as qualified expenses any way we need to, so long as the equation balances?
A. Yes, unless you absolutely, positively know that number is wrong.
Q. But it’s okay to use that $10,526 as qualified expenses any way we need to, so long as the equation balances?
A. Yes. And the term "equation balances" is applied very loosely.
Q. Finally, the amount of the scholarship or fellowship grant that is applied to non-qualified expenses can't exceed the amount of the student's actual non-qualified expenses that are paid in the tax year.
A. That's pretty meaningless. "Non-qualified expenses" can include many things not previously mentioned. Transportation being a prominent example. It certainly includes the $2341 of room & board not already allocated and any other food consumed by the student.
Q. Am I being too literal?
A. Yes. The first time I heard that you could claim a tuition credit even with a scholarship, I said that's too stupid to be true. But there it is and everybody's doing it, and the IRS is encouraging it.
