The IRS took my tax refund for this year and applied it to my tax debt. The thing is the debt doesn't seem to be going down any. Am I just crazy or is something fishy going on here?

You're not crazy, but the IRS doesn't exactly play fair when they apply money to your tax debt. Basically the IRS applies the money to the penalties and interest first, and if there's any money left over that goes towards the principle. It's the same with an IRS payment plan. Your payments always go towards the penalties and interest before it goes to the principle.

Why can't I just pay the principle on my IRS tax debt and be done with it? Why do I have to pay interest and penalties on something that isn't even a loan?

Like any other debt the IRS gets to assess penalties and interest on your tax debt. The penalties are for not paying off your debt and the interest gets added on top of that. The IRS claims this encourages people to pay off their debt faster, but it can feel like they're doing it so you'll never pay off your debt, and the IRS will be collection on your tax debt forever.

I'm already in a payment plan with the IRS and I haven't missed a payment. If I've already agreed to a monthly payment amount why does the IRS still take my tax refund?

Even though you're paying them every month that tax refund belongs to the IRS until your debt is paid off. The IRS can apply your tax refund to any tax debts you have before you'll even see it. Better luck next year.

I received a lump sum disability payment after fighting 4 years to get it. The IRS knows I'm on disability and they know what my normal income is. So why is it that I get pushed into a higher tax bracket and now owe the IRS because the government held back my disability payments?

That does seem unfair, but unfortunately disability is taxable income and there are no special deductions or credits available for that. And since it is taxable income it does put you into a higher tax bracket for that tax year.

Now you have the smoking gun...Use it!