The United States will give a UN agency $60 million in aid for Palestinian refugees but withhold a further $65 million for now, the State Department said.
State Department spokeswoman Heather Nauert echoed US President Donald Trump in calling on other nations to provide more funds because he believes the United States pays more than its share.
The decision to keep back some money is likely to compound the difficulty of reviving Israeli-Palestinian peace talks, particularly following Trump's December 6 recognition of Jerusalem as Israel's capital.
A Palestinian official quickly criticised Washington's decision to withhold some of the money and United Nations Secretary-General Antonio Guterres said he was unaware of any cut in aid but he was "very concerned" about the possibility.
The State Department notified the United Nations Relief and Works Agency for Palestinian Refugees of the decision in a letter, Nauert said.
She said the Trump administration was conditioning the release of the additional funds on whether the organisation makes unspecified reforms.
She insisted, however, the decision was "not aimed at punishing" anyone.
In a Twitter post on January 2, Trump said that Washington gives the Palestinians "HUNDRED OF MILLIONS OF DOLLARS a year and get no appreciation or respect."
