The State Department said the US would at the same time increase humanitarian aid to the Palestinians through United Nations agencies.
Department spokesman Sean McCormack said the suspension would be lifted if the Palestinian cabinet recognised Israel's right to exist and renounced violence, as called for by the Quartet group of Middle East mediators.
Quoting a statement by Condoleezza Rice, the secretary of state, he said US humanitarian aid to the Palestinians through UN or other relief agencies would be increased by 57% this year to $245 million.
The United States will cancel or suspend up to $411 million in Palestinian aid.
Another $13 million will go for new safeguarding procedures, including a special inspector general, to ensure that even humanitarian aid funnelled through the UN relief agency and approved charities does not end up with Hamas, the department said.
The money being cut or suspended includes funds for public works construction, training public officials and revitalising the economy.
The United States has long channelled most of its assistance to the Palestinians through indirect means, to humanitarian efforts such as food, maternal and child health programmes and education and for projects that only indirectly benefited the Palestinian government.
These include such projects as roads, water works and training programmes for judges, electoral workers and others.