What is best way for college kiddo to lower tax amount? upcoming freshman has 20K in scholarships in excess of tuition and fees. Should she start an IRA with her cash?

Q. What is best way for college kiddo to lower tax amount?

A. There is none. In fact, it's best of she pays more tax, so the parents can get a tax break (more on this below). 

Q.  Should she start an IRA with her cash?

A.  Yes and No. Taxable scholarship is not "compensation"*.  She can make an IRA contribution based only on her summer job income (up to $6500 [2023]). 

Q. What is the tax rate of a dependents on 25K?

A. There's more bad news (and some good news). Scholarships are a hybrid between earned and unearned income. It is earned income for purposes of the $13,850 (2023) filing requirement and the dependent standard deduction calculation (earned income + $400, but not more than $13,850).  It is not earned income for the kiddie tax and other purposes (e.g. EIC or IRA contribution*).  So, the first $13,850 will not be taxed. The rest will be taxed at the parent's marginal tax rate (the "kiddie tax")**.  The part of the scholarship that goes to "qualified educational expenses" (QEE) is not taxed. QEE is tuition, fees, books, computer and other "course materials". 

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 $25,000 in box 5 of the 1098-T and $10,000 in box 1. At first glance he/she has $15,000 of taxable income and nobody can claim the American opportunity credit. But if she reports $19,000 as income on her return, the parents can claim $4000 of qualified expenses on their return. $4000 of expenses gets the parents the maximum $2500 AOC. 

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 $18,000 of taxable scholarship income, instead of $19,000.

*For grad students and post grad fellows (but not undergrads), scholarship, stipend and fellowship income is earned income ("compensation") for IRA contributions.

**A small portion  may be taxed at the student's rate (10%), depending on the actual numbers.    See form 8615 for the complicated calculations. For more on the kiddie tax and scholarship income, see this related post: https://ttlc.intuit.com/community/college-education/discussion/kiddie-tax-on-scholarship/00/2449625