At tax time, you are (pretty much) free to allocate your expenses where they will benefit you most.
-First we allocate $3000 of tuition + $1000 computer to the American Opportunity Credit (AOC).
-That leaves $11,796 of tuition for the scholarship
-$35,849 - 11,796 = $24,053 of the scholarship is taxable on the student's return. Taxable scholarship is earned income for purposes of the dependent's standard deduction.* So, he gets a $14,600 standard deduction. It is unearned income for the kiddie tax.
-We allocate the $11,672 Room & board (R&B) to the 529 distribution. This means the distribution is 11672 / 36935 = 31.6% qualified. 68.4% unqualified x $21,359 earnings = $14,610 taxable income from the 1099-Q.
Theoretically you can enter 1098-T, in TurboTax (TT), on your return and the 1099-Q), then the 1098-T on the student's return , answer all the questions and TT will come up with those conclusions and put it on the forms.
But mistakes are frequent. I strongly recommend short cuts:
-On your return, enter the 1098-T with $4000 in box 1 and box 5 blank.
-On the student's return, enter the 1098-T with 0 in box 1 and $24,053 in box 5.
-On the student's return, enter the 1099-Q. When asked who the student is, answer: someone else not listed here (lying to TurboTax to get it to do what you want does not constitute lying to the IRS). Enter the student's name when asked. A few screens later, you'll get one simple screen to enter expenses (enter all expenses, don't adjust). Press Done at the 1099-Q summary screen, to get there. Also enter the total amount of the scholarship in the box "Tax-free assistance". This reports the earnings as taxable and claims the scholarship exception. You do not have to deal with the complicated “Educational expenses and Scholarships” (1098-T) section later. TT will prepare form 5329 to claim the penalty exception.
*Scholarships are a hybrid between earned and unearned income. It is earned income for purposes of the $14,600 filing requirement (2024) and the dependent standard deduction calculation (earned income + $450). It is not earned income for the kiddie tax and other purposes (e.g. EIC). For grad students and post grad fellows, scholarship, stipend and fellowship income is earned income ("compensation") for IRA contributions.
Taxable scholarship goes on line 8r of Schedule 1, from which TT treats it as hybrid income.
