You can say either, both have different implications.
Technically you would say Karen was Ann's sister.
Saying Karen is Ann's sister implies that you have not accepted the death, or because the death was so recent, it is more respectful to refer to their relationship in present tense.
I'm not sure any of them would fit (the first is fine, but it doesn't say anything about Ann).
I couldn't say "Karen was Ann's sister." For one, she is still alive. And I suppose that, for Karen, Ann will always be her sister. I would easily say "Ann was Karen's sister," because that would be understandable (if not necessarily technically correct).
"Karen is sister to the late Ann" is somewhat stilted, but at least I would know what I'm talking about.