It depends on your living arrangements. If you, your children and your sister live in the same home, you can decide between you who will claim the children (your sister must meet rule 6). You can claim some and she can claim some. If you can't agree, you have first choice as parent. It may be worthwhile to prepare trial returns, to see which way the family comes out best. This tool may be useful: https://turbotax.intuit.com/tax-tools/calculators/taxcaster/?s=1.
There are two types of dependents, "Qualifying Children"(QC) and Other ("Qualifying Relative" in IRS parlance even though they don't have to actually be related). There is no income limit for a QC but there is an age limit, student status, a relationship test and residence test. Only a QC qualifies a taxpayer for the Earned Income Credit (the EIC maxes out at 3 children) and the Child Tax Credit. They are interrelated but the rules are different for each.
The support test is different for each type. The support test, for a QC, is only that the child didn't provide more than half his own support. The support test for a Qualifying Relative is that the taxpayer provided more than half the relative's support.
.A child closely related (aunt counts*) to a taxpayer can be a “Qualifying Child (QC)” dependent, regardless of the child's income, if:
- He is under age 19, or under 24 if a full time student for at least 5 months of the year, or is totally & permanently disabled
- He did not provide more than 1/2 his own support
- He lived with the relative (including temporary absences) for more than half the year
- He is younger than the relative (not applicable for a disabled child)
- If the child meets the rules to be a qualifying child of more than one person, you must be the person entitled to claim the child as a qualifying child (this essentially means that you have the parent’s permission to claim the child, if the child also lived with the parent more than half the year)
- If the parents of a child can claim the child as a qualifying child but no parent so claims the child, no one else can claim the child as a qualifying child unless that person's adjusted gross income (AGI) is higher than the highest AGI of any of the child's parents who can claim the child.
See full dependent rules at: https://turbotax.intuit.com/tax-tools/tax-tips/Family/Rules-for-Claiming-a-Dependent-on-Your-Tax-Ret...
https://www.irs.gov/help/ita/whom-may-i-claim-as-a-dependent
*"Guardianship" is not relevant in your situation, since an aunt is considered closely related.
