Crew members demanded their surrender at gunpoint. When the men kept trying to start their engine, the Coast Guard crew doused them with pepper spray.
The two suspects were detained. Authorities believe they had been supplying gasoline to other smuggling craft operating off the California coast.
Horne arrived in Southern California last summer after serving for two years as an executive petty officer in Emerald Isle, N.C.
There, he received a Coast Guard Commendation Medal for his leadership in 63 search-and-rescue cases, in which 38 lives were saved.
"He is the best shipmate I've ever known. He was a friend. He was a big brother to us all and he's absolutely irreplaceable," said Lt. Steward Sibert, commanding officer of the cutter Halibut.
He understood and he lived the Coast Guard motto or honor, respect and finally giving the ultimate sacrifice of devotion to duty," said Executive Petty Officer Kellian Whidden.
Horne leaves behind a wife and a young son. According to neighbors in Redondo Beach, Horne's wife is pregnant with the couple's second child.
U.S. Homeland Security Secretary Janet Napolitano released the following statement:
"I am deeply saddened to learn of the death of U.S. Coast Guard Boatswains Mate Chief Terrell Horne during a counter-drug operation yesterday morning near Santa Cruz Island, California."
"BMC Horne and his fellow crew members of the USCG Cutter Halibut were engaged in an at-sea interdiction when they came under threat by a small vessel that rammed their small boat.
"This tragedy reminds us of the dangers our men and women in uniform face every day, and the great risks they willingly take, as they protect our nation.
"Our thoughts and prayers are with the family of BMC Horne and all of our Coast Guard personnel at this difficult time."
Memorial Held for U.S. Coast Guardsman Killed in Panga Crash
Chief Petty Officer Terrell Horne, 34, with his wife and child. (KTLA-TV)