Reserve 1 tablespoon of the crushed lemon drops. Add the remaining lemon drops and next 9 ingredients to a 1-1/2- or 2-pound bread machine according to the manufacturer's directions, adding the lemon drops with the flour. Select the basic white bread cycle and desired color setting.
In a small bowl combine powdered sugar, lemon juice, and vanilla. Stir in enough milk (1 to 2 teaspoons) to make an icing of drizzling consistency. Drizzle over cooled loaf. Sprinkle with the reserved lemon drops.