Unfortunately, since the business is already closed (in 2008), you will not be able to take any type of business deduction related to this business in the current year.
Additionally, the payoff of this loan with money from your 401(k) will be considered by the IRS to be a personal use of this money. Therefore, you will need to include this cash withdrawal from your 401(k) (reported on Form 1099-R) on your income tax return and will need to pay income taxes on this withdrawal.
As you mentioned, this withdrawal may be subject to an additional 10% early withdrawal penalty unless you met one of the exemptions (paying off a personal business loan with these funds is not listed as an exemption).
See IRS Tax on Early Distribution from a Retirement Plan for information about these
exemptions.
