If I take an early distribution from my 401K it will be taxable income as well as a 10% penalty. Let's say the penalty is $5K ($50K withdrawal). If I was unemployed and the deductions exceed my taxable income can that be applied toward the penalty?

Withdrawal from 401K is treated as ordinary income just like your other income like wages, interest and dividends.
If your itemized deductions exceed your Gross income, you have a negative income.
Read http://taxipay.blogspot.com/2008/08/...01k-plans.html

The 10% Early Withdrawal Penalty cannot be mitigated by deductions, credits or exemptions.

That means that, even if all of your exemptions and credits offset the normal income taxes, resulting in negative income, you STILL would have to pay the $5,000 in Early Withdrawal Penalties.