It is OK to do it the way they are doing it, if they are in agreement to do so.
The proper way is for the sister to report the whole 1099-INT amount on her return and then take a deduction for "nominee" amount (presumably half the interest). In TurboTax (TT), the sister will get a screen asking if she needs to adjust the amount. The deduction goes on Schedule B and is not an itemized deduction.
You wife enters her share of the interest at the 1099-INT screen, in TT, even though she did not actually get a 1099.
