The decision by President Joe Biden's administration reverses a move made under Donald Trump that rejected the wide international consensus that Israel illegally occupies the West Bank, which it seized in the 1967 Six-Day War.
New guidance to US government agencies advises that "engaging in bilateral scientific and technological cooperation with Israel in geographic areas which came under the administration of Israel after 1967 and which remain subject to final-status negotiations is inconsistent with US foreign policy," State Department spokesman Matthew Miller said.
He stressed that the United States "strongly values scientific and technological cooperation with Israel" and said the restriction on West Bank funding "is reflective of the long-standing US position going back decades."
The decision will most visibly apply to Ariel University, a major academic institution founded in 1982 on what was then a new settlement in the West Bank.
Members of the rival Republican Party swiftly attacked the decision.
Senator Ted Cruz, known for his outspoken criticism of Biden, slammed the administration for what he called "anti-Semitic discrimination" against Jews in the West Bank, and said it was "pathologically obsessed with undermining Israel."
David Friedman, Trump's ambassador to Israel and champion of Ariel University, accused the Biden administration of embracing the activist movement to boycott Israel.
The administration however says it opposes the Boycott, Divestment, Sanctions movement, which calls for severing ties with Israel as a whole, not just settlements.
Under Trump's secretary of state Mike Pompeo, Washington took actions to normalize Israeli settlements in the West Bank including by letting their products be labeled as "made in Israel."
The Biden administration has gone back to the long-standing US position of calling for a two-state solution with the Palestinians and criticizing settlement expansion under Prime Minister Benjamin Netanyahu.
Washington has stopped short of any substantive effort at negotiating a peace deal, seeing prospects as highly unlikely with Netanyahu, who is leading the most right-wing government in Israeli history.
