Technically, under strict English rules of grammar, the "correct" answer would be "With whom is your sister?", but that is so atrociously awkward, nobody would say it that way.
The problem with the colloquial correct answer is that the phrase "Who is" sounds like a subject-verb pair, which is an explanation of why it is used so frequently. Of course, it's not a subject-verb sequence - but it sounds so much like one that many English-speakers are more comfortable with it than "Whom is", which sounds weird.
"Who(m) is your sister with" is technically not proper grammar, but it's how 99.9+% of English speakers would say it, even those who know it's "wrong". I think accepting it is as a translation is best -- there would be lots of complaining if it wasn't. I wonder if "With whom is your sister?" is accepted...
"With whom is your sister?" is accepted (April 28, 2016). :-) Though I think it should really be the default answer (with the others as alternatives, of course). Since the Russian pronoun is not in the nominative case, the appropriate English pronoun is the object pronoun.
"Who is with your sister" is wrong. "Your sister" is with somebody, not the other way round.
And Duolingo is not ruled by AI. The lists of accepted answers are manually maintained by the contributors. If there is a legitimate correct answer that is not currently accepted you can use the report functionality to improve the course.
Interesting grammatically. "With whom.." is the accurate translation. In practice, if you saw your sister with someone, no one would criticise or misunderstand or be confused if you used the other variants. The only version that might raise eyebrows if used colloquially would be the correct "With whom.."
I was talking from a meaning perspective rather than grammatically. "Who is your sister with?" should be accepted given general English usage, despite the preposition dangling. But "Who is with your sister?" has a different meaning (albeit slightly different) with a different translation.