The islands in dispute are the Spratly Islands, Paracel Islands, and Paratas Islands. There are also the Scarborough Shoal and the Macclesfield Bank which is in dispute. There is also dispute in claim for the maritime territories.
Currently the various territories in the South China Sea are being claimed by certain groups in the region;
China (People's Republic of China)
In essence is claiming the entirety of the South China Sea, which include the Paracel Islands, and the Spratly Islands as well. For further clarification, you might want to look into the "Nine dotted line". The "nine-dotted line" boundary, is of course being disputed by the Phillipines, Vietnam, Malaysia and Indonesia.
Personally, I feel that China is over-reaching with its claim. The basis for the claim is history; which is shaky at best and at worst, works against them since many academics have put forward that historically, Vietnam has a prior claim on the Paracel Islands (allegedly) . Furthermore, China is a signatory of the 1982 United Nations Convention on the Law of the Sea (UNCLOS), and as such, the Nine Dotted Line claim is a HUGE stretch, by any means, even if the territories (Paracel and Spratlys) are conceded to China.
However, with its formidable Navy, China has the best means by which to assert and defend its claim. The Paracel Islands, for example, even though is being claimed by Vietnam (and Taiwan as well), is currently being administered (and occupied) by China. The likelihood that China would drop its claim and unoccupy the islands diplomatically is highly unlikely.
Taiwan (Republic of China)
The Republic of China were in fact the original group that put the claims as per the Nine Dotted Line while they were still based in China, as such they are also following through with those claims (on top of claiming sovereignty over mainland China as well). Beyond that, they are disputing China's claim on the Paratas Islands, the the Scarborough Shoal (also claimed by the Philippines , and the Macclesfield Bank (also claimed by Philippines and Vietnam).
The validity of their claims is the same as China's, however they are significantly less able to enforce their claims. The Scarborough shoal and Macclesfield Bank claims are especially hard to determine as they are largely underwater bodies, and they can't be claimed by possession.
The Philippines
The Philippines are claiming a portion of the Spratly Islands, the Scarborough Shoal, and the Macclesfield Bank.
The basis for Philippines' claim on the Spratlys lies in res nullis (it belongs to nobody, so they have claimed it) and Geography (the islands, are closest to their territories, and hence should belong to them). The Philippines' claim (based on res nullis) is interesting, to say the least, as it would allow them to keep whichever islands they are currently occupying however, it significantly diminishes their claim on the territories claimed by other parties, which a significant portion of it is.
To assert its claim, the Philippines have occupied and declared the claimed islands in the spratlys as a municipality in the Palawan Province. By setting up a settlements (primarily composed of fishermen) on the claimed islands and undertaking works on the island, Philippines have started precedence to cement their claim in the international arena by exercising sovereignty.
Vietnam
Vietnam is claiming the Paracel Islands and the Spratlys.
Prior to the "Nine Dotted Line" and even the "Eleven Dotted Line", the possession of the Paracel Islands have been inconsistently held between the Vietnamese and the Chinese. While Vietnam was under colonial rule, the French held and administered the islands on behalf of their colony, Vietnam.
During the second World War, the Japanese defeated the French and took over the Paracels. However, following their defeat at the end of the war, the Japanese renounced their claim on those territories. China then took control of the Amphrite group of islands in the north-east, while Vietnam took the Crescent group, in the south-west.
However in 1974, near the end of the Vietnam War, but not as part of that war, South Vietnam found that the People's Liberation Army Navy (PLAN), was in the vicinity of the Paracels and were deploying military forces on the islands. This resulted in the Battle of the Paracel Islands, which concluded in PLAN taking possession of the islands. Vietnam did not (or could not) regain possession of the island due to already being engaged on the mainland with North Vietnam and also due to the refusal of their American allies to get involved. The Chinese have held the Paracel Islands ever since.
This forms their basis for their claims on the Paracel; that they have held sovereignty on the islands until it was invaded by China.
With regards to the Spratlys, Vietnam has claimed that it has exercised sovereignty on the islands since the 17th century. After the French left, Vietnam has placed border markers on the Spratlys to indicate their possession of the islands. Currently, Vietnam occupies 31 of the islands.
Malaysia
Malaysia claims part of the Spratlys; 7 islands in the southern portion of the archipelago that they consider to be within its continental shelf (off the island of Borneo, as part of East Malaysia). The Malaysians have military presence on 3 of the islands. This claim comes from the continental shelf principle, however, the islands still needs to be res nullis.
Brunei
Brunei (similar to Malaysia) base their claim on the Continental shelf principle but also have declared an Exclusive Economic Zone encompassing one of the islets. Militarily, Brunei does not have any presence on the island.
Indonesia
Indonesia does not claim any of the islands but on maritime rights.
Conclusion
These disputes seem to the be the driving force in the recent and increasingly rapid modernization of military capabilities for Countries in the region and especially their naval capabilities. The economic situation seem to be the limiting factor in this development. This is not true for China, fueled by their growing economy and showcased by their ability to put together a Naval Task Fleet to attend to these conflicts.
Observers fear that accelerated modernization of the military capabilities will cause destabilisation in the region. However, due to the economic constraints, there are some who suggest that this could also lead to naval cooperation between the navies.
Diplomatic efforts to resolve these issues are taking place, albeit slowly, and haltingly. An agreement in 2011, between China, Brunei, Malaysia, and Vietnam set some preliminary guidelines to resolve the issues as well as considerations in environmental protection, scientific research, safety in navigation and communication, search and rescue, and combating transnational crime.
How this issue will play out is anyone's guess.
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