Q. I am thinking she files the 1098-T but excludes the tuition amount from any credits, and I file nothing at all.
A. That's one way to do. At first glance, it's the "correct"way.
But, it's not the best way. She should claim all the tuition (up to $10,000) because that will get her the maximum tuition credit of (up to) $2000. You claim the rest of the tuition, any books and a computer (if one was purchased for school) and room & board (even if she lived at home). The Lifetime Learning Credit is 20% of tuition paid. It is non refundable so it can only be used to reduce an actual tax liability.
Even if you are in the 22% tax bracket, the family usually comes out better if she claims the full credit. The box 1 amount on the 1099-Q is not what gets taxed. It's the earnings in box 2 and it's only a percentage of that. The 10% penalty will not apply because of the exception when the credit is claimed.
