Hello and thank you for using Just Answer,IRS will send your refund to the Chapter 13 Trustee, unless IRS elects to offset a prepetition refund (keep it and apply it to any back taxes you may owe to IRS). Under BAPCPA, the automatic stay does not prohibit the IRS from setting off prepetition income tax refunds against prepetition income tax liabilities. 11 USC § 362(b)(26). Where the automatic stay prohibits other types of setoffs, the IRS can temporarily retain a refund to preserve its setoff rights.
The answer is that the IRS can keep it but only the IRS agent can say for sure if they will.
The IRS will send you and your attorney a written notice telling you what they have done if they do offset the refund.
See Section 362(b)(26) of the Bankruptcy Code for setoff rights by the IRS.
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IF the IRS refunds the overpayment to the trustee, will that amount reduce (or apply to) my currently required $500 mo payment schedule?
If the amount is applied then the plan would be modified. You would have to ask your attorney or call the trustee's office directly to speak on specifics of the modification of your payments.