State Farm Insurance Co Sold me a whole life policy, but now threaten to report me to IRS Bloomington, Illinois

In 1978 my husband and I, as young newlyweds, bought a $20,000 whole life insurance policy from our State Farm Agent.  We were told how wonderful this policy is, how it's a great financial investment, a source of income and death benefit when needed.  Years later, 2009, we are being threatened by them to either pay $600 to keep the policy in force, or they'll report $7,000 capital gain to the IRS!  I was floored.  I've spoken several times to the person at the State Farm office in Bloomington.  It seems our dividends were to pay the annual premiums.  The additional dividends purchase additional insurance.  Somewhere along the line, there were "loans" taken out against the policy.  The only one I remember was about $400, many years ago.  They also took out loans from our policy to pay premiums on an additional "rider" we purchased in 1986.  This was all put on our original $20,000 policy and now apparently we owe $11,000 with interest back to this policy!  Every year, when I received notices from the company, I would call our agent and he would say not to worry about it; it was our money and didn't have to pay it back.  It has escalated to $11,000 and we're in "excess loan situation" on our policy.  Either pay more money now, or they'll report $7,000 capital gain to the IRS this year.  Also, we're to pay another chunk of money down next year, plus make additional monthly payments to keep the policy in force.  I was never told about this from our agent.  I was never told our dividends  could have gone to pay back this loan and interest. Instead, it was buying "additional coverage" for us.  Now, they tell us we can't touch this additional dividend amount to pay this loan back.  I believe the company misrepresented this policy and I'm crying fraud for all the promises they made us , which has now turned into a tax nightmare.