I was laid off last year and only got paid for one month. I had to withdraw my 401K funds to get over the loss of income and to keep paying my home loan. Now, while doing my taxes, I ma being charged a 20% penalty (besides the 10% that I already paid while withdrawing). Also, my tax refund is much lower than I expected probably due to this. How can I avoid losing money like this and get a better refund?

You can't. First, you are misunderstanding the penalties. If you take an early withdrawal from a 401(k), you have to pay taxes on the amount of the withdrawal as income. Generally the plan will withhold 20% towards your tax liability, just as taxes are withheld from your paycheck. In addition to the taxation there is a 10% penalty that has to be paid.

The only way you could have avoided this is not taking the money out of the 401(k). Once you did that you incurred taxes and penalties.

Is there a way to show unemployment as 'hardship' to waive the penalty and taxes? I would not have withdrawn the 401k funds unless I really needed them to continue my house payments...

Is there a way to show unemployment as 'hardship' to waive the penalty and taxes? I would not have withdrawn the 401k funds unless I really needed them to continue my house payments...

Sorry, but no. Even if your withdrawal qualified under the hardship withdrawal rules, the penalty still applies.

A 401(k) allows you to save money tax deferred. Meaning you pay no taxes on the amounts deposited until you withdraw them. There is a price for getting this advantage. So the 10% penalty applies no matter why an early withdrawal is made.

The tax liability is mitigated because your income should have been low enough to have the withdrawal taxed at the lowest rate.