Prime Minister Sharon needs Labour to rebuild his shattered coalition and overcome the hardline right-wing opposed to withdrawing troops and Jewish settlers from the occupied Gaza Strip, under a plan welcomed by Western countries as a possible step to Middle East peace.
"Let this be clear: There will be a government," chief Labour negotiator Haim Ramon told Israeli Army Radio.
"The question is whether we will sit in this government with significant cabinet portfolios, or if we enter this government without portfolios."
Sharon and Labour leader Shimon Peres began coalition talks on Saturday after receiving a nod from their respective parties.
Sharon lost his parliamentary majority by firing his biggest coalition partner, the secularist Shinui party, on 1 December in a spat over funding for religious groups. Hardline, far-right allies had left earlier over the Gaza plan.
Fearing early elections, Sharon has been scrambling to rebuild his government and push through the initiative.
The project envisages evacuating all settlements in the Gaza Strip and just four of 120 in the West Bank.
Both territories were seized by Israel in the 1967 Arab-Israeli war.
Buoyed by new hopes of peace after Yasir Arafat's death last month, Western countries see the Gaza plan as a positive move.
But Palestinians fear Israel will use it as a ruse to strengthen its hold on the West Bank where Sharon has said he wants to seize more territory.