The Form 1099-R indicates that you were one who inherited the money, not your sister, and it is taxable to you. Any portion of the money that you gave to your sister was a gift from you to your sister. If the amount that you gave to your sister was more than $14,000, you must file a gift-tax return.
In these circumstances, it's customary to split the distribution after subtracting the additional tax liability that you incurred by receiving the distribution. For example, if your marginal tax rate on the additional $35,000 of income to you is 25%, $8,750, you would typically split the remaining $26,250 between you and your sister. In this example the $13,125 that you gift to your sister would also be under the $14,000 gift-tax exclusion amount. Your actual marginal tax rate may be different, though.
