The plan to promote alternatives to Hamas includes funding to restructure the Fatah movement which was beaten in general elections in January after the electorate became disillusioned with a government it saw as increasingly corrupt.
The Palestinian president, Mahmoud Abbas, is also head of the Fatah movement.
The money will also go to training and strategic advice to politicians and secular parties opposed to Hamas.
One official US document obtained by Reuters said: "This project supports [the] objective to create democratic alternatives to authoritarian or radical Islamist political options."
The US campaign coincides with signs that Abbas is considering sacking the government in a process that could lead to a new parliamentary vote.
US officials and consultants say the effort is being conducted without fanfare in order to protect the Palestinians who are receiving US help - some already branded by Hamas leaders as collaborators with Washington and Israel.
"We don't operate with firecrackers and neon signs to attract attention to ourselves," said one of the contractors working with Fatah on behalf of the US state department.
US funds will also be used to encourage "watchdog" groups and local journalists to investigate the activities of the Hamas-led government and parliament. Up to $5 million would support private Palestinian schools offering an alternative to the public education system.
In a response, Jacob Walles, the US consul general, said: "There is nothing new here. The US has operated programmes in the West Bank and Gaza for many years to promote the development of political parties and civil society organisations."
"We are not promoting any particular party. In fact, we will work with any party as long as it is not affiliated with a terrorist organisation," Walles said.
There would be no direct funding of parties, he stressed.
Some Hamas leaders have accused Abbas and Fatah of serving the interests of Israel's ally, the US, which has led a Western aid embargo to force Hamas to recognise Israel, renounce arms and accept past accords with Israel.
Washington is also helping Abbas expand his presidential guard.
Fathi Hammad, a senior Hamas political leader and politician, called the US money part of a plot to bring down the Hamas-led government.
"It is a challenge that we are aware of and we will confront it," he said.
In the Gaza Strip and occupied West Bank, $42 million could go a long way - it is more than three times the total spent by the main parties and candidates in the January election.
Ahead of that election, the United States tried to help the then Fatah-led Palestinian Authority, but critics said the push came too late to assist the long-dominant movement, which was handicapped by infighting and accusations of corruption.
The US-based National Democratic Institute (NDI) said it recently began talks with the leaders of Fatah and other parties about how they could improve their performance in any election.
Michael Murphy, who runs NDI operations in the West Bank and Gaza, said the focus for now was on internal party reform, but that the programme, in coordination with the state department, would look for ways to help Fatah and others get their message across.
The International Republican Institute, which has also worked in the West Bank and Gaza for years, recently received funds for a new programme to give training and strategic advice to several Palestinian independent parties, though it said politicians would not get direct financial help.