It's hard trying to please the "unplease-able."
I just don't understand. It seems like I can do nothing correct.
It sounds as if you have the hope that you can please your MIL or show her that you can do what she wants in a way that will satisfy her; is this correct?
From your posts, your MIL exhibits behaviors of someone with a mental illness. Your MIL is unhappy and ill; there is nothing you can do--correctly or incorrectly--to change her behaviors or beliefs. She is who she is. You can, however, concentrate on your "stuff/behaviors" and working on yourself like you've been doing. The way that your MIL keeps changing her requests and upping the ante would suggest that the work you are doing on yourself is causing a change--even though the change is often stressful for you.
It sounds like you have two issues that are causing you distress: 1) taxes (legal/values-boundary) 2) DD's relationship with MIL (family/values/boundary).
It doesn't seem legal that your MIL can keep your taxes until she talks to you. It also seems inappropriate that a parent holds hostage the taxes of an adult (married!) child--even though your DH obviously made the original decision to give them to her based on fear/anger when it looked like divorce was pending.
However, I don't know how confrontational/worth it it would be to legally demand the taxes from her. This seems like something your DH should deal with (it's his mom)--is he seeing a T? Maybe this is something he can work on figuring out with the marriage T or individual T.
The DD/MIL relationship is another issue, and your concern and fear are understandable given the experience of your older DD. Again, this seems like something that would be valuable to bring to your marriage T together. Think about what your values are for your DDs and their relationships. Maybe you and your DH can come up with some shared values for how you want your DDs--both DDs--to be treated and create values-based boundaries around those shared values.