Q. Does any of this have to be declared on 1040 (excess income)?
A. Yes. Scholarships that pay for qualified educational expenses (QEE - tuition, fees, books and other course materials) is tax free. Scholarship amounts that exceed QEE is taxable income, on the student’s tax return. Room and board are not QEE, so money applied to "dorm bill" is taxable.
If box 5 of the 1098-T exceeds box 1, TurboTax (TT) will treat the difference as taxable income, unless you enter additional QEE at books and other expenses. The fact that None of the money from box 5 was refunded, does not make it non taxable.
Furthermore,
There is a tax “loop hole” available. The student reports all his scholarship, up to the amount needed to claim the American Opportunity Credit (AOC), as income on his return. That way, the parents (or himself, if he is not a dependent) can claim the tuition credit on their return. They can do this because that much tuition was no longer paid by "tax free" scholarship. You cannot do this if the school’s billing statement specifically shows the scholarships being applied to tuition or if the conditions of the grant are that it be used to pay for qualified expenses.
Using an example: Student has $10,500 in box 5 of the 1098-T and 13,000 in box 1. At first glance he/she has $2500 of taxable income and nobody can claim the American opportunity credit. But if she reports $6500 as income on her return, the parents can claim $4000 of qualified expenses on their return.
Books and computers are also qualifying expenses for the AOC. So, extending the example, the student had another $1000 in expenses for those course materials, paid out of pocket, she would only need to report $5500 of taxable scholarship income, instead of $6500.
