The IRS FAQ on the subject says this:
If you receive a scholarship or fellowship grant, all or part of the amounts you receive may be tax–free.
Qualified scholarship and fellowship grants are treated as tax–free amounts if all the following conditions are met:
1. You are a candidate for a degree at an educational institution that maintains a regular faculty and curriculum and normally has a regular enrolled body of students in attendance at the place where it carries on its educational activities;
2. Amounts you receive as a scholarship or fellowship are used for tuition and fees required for enrollment or attendance at the educational institution, or for books, supplies, and equipment required for courses of instruction; and
3. The amounts received are not a payment for your services.
However, if you receive a scholarship award under the National Health Service Corps Scholarship Program or the Armed Forces Health Professions Scholarship and Financial Assistance Program, the amount received is tax free without regard to any services you are obligated to perform.
You must include in gross income amounts used for incidental expenses, such as room and board, travel, and optional equipment, as well as amounts received as payments for teaching, research, or other services required as a condition for receiving the scholarship or fellowship grant.
In addition, for that portion of your tuition and fees which are not covered by scholarship, you can either (a) deduct up to USD$4000 from your income for tax purposes (if your income is less than USD$80,000), or (b) obtain a lifetime learning tax credit worth up to $1500 (if your income is less than USD$53000).