Do not report a dependent student's taxable scholarship on your tax return. If it needs to be reported, it goes on the student's separate tax return. If the amount of taxable scholarship is less than $12,400 and that is the student's only income, it does not need to be reported (the student does not need to file a tax return). If it needs to be entered (on their returns), it gets entered in the educational expenses section of TurboTax (TT), not the income section.
You do not need the room and board amounts for this issue (unless you also have 529 plan distributions).
The student with more in box 1 does NOT have taxable income (see exception below). There's an error.
For the other student, only the difference between box 5 and box 1 is taxable and that difference can be reduced by other qualified expenses (books & computers, but not room & board) not included in box 1. The Box 5 amount is NOT the taxable amount.
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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 $10,000 in box 5 of the 1098-T and $8000 in box 1. At first glance he/she has $2000 of taxable income and nobody can claim the American opportunity credit. But if she reports $6000 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 $5000 of taxable scholarship income, instead of $6000.
