Loan on my 401K

In 2006 I took out a loan on my 401K to start a business ......... but still working my full time job. The loan Payments were 502.00 Per month ....... they did not start deductions from my check until April of 07 . This was 8 months after my Loan.

Since the Deductions for the loan I have paid $172.82 per week or 691.28 per month.

Yesterday I recieved a letter yesterday from the IRS saying that this was a Disturbution and not a loan for some reason and I owe 10,000 In Tax and Penalties.

I do not know what has happen or how this has happened ? But to date I have paid over 18,000 back to my 401K loan.

Now my Questions are this

If I pay the 10,000+ in tax and penalties ............... what happens to the money I had been giving to pay the loan ?

From what I have found out ...... they send a wrong 1090 to the IRS saying is was a payout and not a loan

In the Current Economy and state of my 401K all the money I have repaid to the 401K has been lost .........Someone has advised my to pay the Fine to the IRS and ask for the repayment money back as I would be 7,500 Ahead ......... as the 401k has lost the 18,000 I had paid back on the loan.