The Shulhan Aruch discusses the proper Beracha to make on a Tallit Katan, mentioning two alternate formulations. Yet, the Sepharadic custom is actually to not make a Beracha at all when putting it on in the morning. Rather, in Shul one makes the Beracha on the Tallit Gadol, having in mind to include the Tallit Katan he is already wearing.
There are many opinions as to how this custom originated. Some say that our Tallit Katan may not be the minimum measure necessary, as there are authorities that hold that it must come down to the knees. Since there is a doubt, a Beracha is not recited. The Eshel Avraham from Botshash maintains that since nowadays, people are embarrassed to wear a Tallit Katan over their clothing, a Beracha is not recited. Others say that even if the Tallit Katan has the minimum measure, it may lose its dimensions when it shrinks in the wash. There is another opinion that one does not recite a Beracha because of the uncertainty as to what is the proper text of the Beracha: "Al Misvat Sisit" or " L'Hitatef B'Sisit."
In truth, all of these reasons can be refuted. For example, the opinion that the Tallit Katan must reach the knees is only a minority opinion; the overwhelming majority maintains that the measure is much shorter. The proposition that people are embarrassed to wear the Tallit Katan is also problematic, because Hasidim do wear their Tallit Katan over their garments. The concern regarding shrinkage is not relevant with today's fabrics. The doubt regarding the proper Beracha is also solved by the fact that Maran clearly rules that one may say "Al Misvat Sisit" on the tallit Katan.
Nevertheless, the prevalent custom is not to make a separate Beracha on the Tallit Katan in the morning. However, if one removes his Tallit Katan during the day for more than half an hour, to go swimming for example, or he puts on a different Tallit Katan in honor of Shabbat, Hacham Ovadia (Yabia Omer 8:2) rules that he should make a Beracha. There is clearly no option of including the Tallit Katan in the Beracha he will make the next morning.
The only question remaining is what is the minimum measure of the Tallit Katan. The Ben Ish Hai holds that one may recite a Beracha if it exceeds 1.5 Amah (cubits) long by one Amah wide. Hacham Ovadia in Ye'haveh Da'at (Vol. 5) and Yabia Omer (Vol. 8) concurs with that Ben Ish Hai. Therefore, many people mistakenly think that this is Hacham Ovadia's final opinion. However, in a later work, Halichot Olam, Hacham Ovadia retracted and held that the minimum measure is two Amot (37.79 inches=96 cm) long by 1 Amah (18.89 inches=48 cm) wide. A Beracha may not be recited on anything less than that. The length is measured excluding the hole for the head. When buying a Tallit Katan, one should insure that his Tallit has these measurements. Of course, according to the Hazon Ish's stricter scale of measurements this would be equivalent to 47.2 inches by 23.6 inches.
It should be noted that the issue of the minimum measure does not affect Shabbat. Hacham Ovadia ruled that a Tallit Katan of any size may be worn outside in the public domain on Shabbat and does not constitute a problem of carrying.
Rabbenu HaAri holds that a Tallit Katan should not have sleeves. Although, a snap or a button is permitted. Accordingly, a Tallit Katan in the form of an undershirt with sleeves over the shoulder would not be preferred.
The Sepharadic custom is to not recite a Beracha on a Tallit Katan in the morning. If later in the day, one takes off his Tallit Katan, he can recite a Beracha when putting one on again, only if the measurements of the Tallit exceed 37.79 inches long by 18.89 inches wide.