The US will give a UN agency $60m in aid for Palestinian refugees but withhold a further $65m “for future consideration”, the State Department says.
The decision would sustain schools and health services, State Department spokeswoman Heather Nauert said in a daily briefing.
Ms Nauert said the department notified the United Nations Relief and Works Agency for Palestinian Refugees (UNRWA) of the decision in a letter.
She said the Trump administration was conditioning the release of the additional funds on whether the organisation makes unspecified reforms.
However, she insisted the decision was “not aimed at punishing” anyone.
Donald Trump tweeted on 2 January saying Washington gives the Palestinians “HUNDRED OF MILLIONS OF DOLLARS a year and get no appreciation or respect”.
He went on: “They don’t even want to negotiate a long overdue peace treaty with Israel… with the Palestinians no longer willing to talk peace, why should we make any of these massive future payments to them?”
The US has provided the Palestinian Authority with budgetary support and security assistance for a long time, as well as the additional funding for UN’s programmes in the West Bank and Gaza.
While Ms Nauert did not link the President’s earlier tweet with the decision, she said the burden needed to be shared.
“The United States government and the Trump administration believes there should be more burden sharing going around,” she said.
Palestinian President Mahmoud Abbas hit out at Mr Trump in a speech on Sunday.
Mr Abbas said: “He said in a tweet: ‘We won’t give money to the Palestinians because they rejected the negotiations.’
“Shame on you. When did we reject the talks? Where is the negotiation that we rejected?”
Mr Trump’s decision to recognise Jerusalem as the capital of Israel has further increased tensions between the US and the Palestinians, who say the move showed Washington could not be a neutral broker in peace talks.