On your return, you enter the 1098-T with $2750 in box 1 and box 5 blank. That will get you $2187 of the maximum $2500 credit. If you have some book and computer expenses, you can add that to the $2750 to qualify for a little more credit (the additional credit is 25% of the additional expenses)
On the student's return, he enters the 1098-T with box 1 blank and $16150 in box 5. He will be allowed the maximum $13,850 standard deduction*, so his taxable income will be 16,150 + 3500 - 13,850 = $5900. The kiddie tax will apply, so that amount will be taxed at the parent's marginal tax rate on form 8615.
*Scholarships are a hybrid between earned and unearned income. It is earned income for purposes of the $13,850 filing requirement and the dependent standard deduction calculation (earned income + $400). It is not earned income for the kiddie tax and other purposes (e.g. EIC).
