Taxpayers who pay qualified higher education expenses with tax-free funds cannot claim a credit for those amounts. Qualified expenses must be reduced by the amount of any tax-free educational assistance taxpayers receive. Ask the taxpayer if the student received any of these tax-free educational benefits:
Do not reduce the qualified education expenses by any scholarship or fellowship reported as income on the student's tax return if the use of the scholarship is not restricted and used to pay education expenses that are not qualified (such as room and board). See Publication 970 for examples of when a student may choose to pay non-qualifying expenses with scholarship/Pell grants funds, making the scholarship/Pell grants taxable.