Me: I really dont want to have an argument, but are we trying to repair our marriage? W: Yes/No Me: If no, "I dont think we can go any further forward" Me: If yes,"Are you still seeing anyone else, if you are we cannot really reapair anything"
Should I tell her I know and set some boundaries?
You can have me and the kids or you can have him? If you wish to carry on you need to move out?
Scared, while there's a divide here between confront and don't confront, the above are controlling (negative) behaviors. Like the 4-horsemen, that's not only unattractive but also weak and ineffective when applied to things you can't control--i.e., you probably can't force her to answer yes/no, to choose between "the kids" and "him", to move out, etc. She chooses who to like and love.
You of course have agency and can decide this is a dealbreaker and file for divorce. She's asked for that before and told you about her affair multiple times (not a strong threat). Boundaries don't require much if any communication. "Do this or else" would be ultimatum territory.
How to behave? When you're unsure, the general rule of thumb is like a Starbucks barista. You would respond to their hello with civility. You would not buy them an expensive handbag. Stonewalling, contempt, criticism, defensiveness--this is what she's used to and why she's seeking other people and has told she was doing so. Don't repeat those mistakes.
As for reporting them to the police, for me, physically harming another human being unnecessarily is against my code of ethics., so I would not report this to the police.