The move has been condemned and donors have pledged to do more to help UNRWA, which provides education for 525,000 children.
In the past few days, over half a million Palestinian children have been returning excitedly to their classrooms after the summer holidays.
But the future of their schools - and the United Nations agency that runs them - have been plunged even deeper into doubt.
Two days after schools reopened with a warning there was only enough money until the end of the month, the United States announced it had halted all funding for the UN Relief and Works Agency' for Palestinian Refugees (UNRWA).
It was the second major American blow for UNRWA. It already faced financial problems after the US - its biggest donor - slashed an annual contribution from $250 million to $60 million in January.
UNRWA has warned that lack of funds means its 711 schools for 525,000 children in Gaza, the West Bank, Jordan, Lebanon and Syria are only guaranteed to stay open only until the end of September. Education accounts for 54% of the agency's spending.
Spokesman Chris Gunness said of the US move: “The impact will be absolutely devastating. It’s likely to be profound, dramatic and unpredictable.”
In the Gaza Strip, where most children attend UNRWA schools, grandfather Hisham Saqallah called the latest US move "political blackmail".
He said: "If they stop aid to schools, this means destroying the futures of a large number of students and throwing them into the street."
Theirworld supporters have been calling for the international community to rally round and help to keep UNRWA's schools open.
The US, announcing its UNRWA decision, called the organisation "irredeemably flawed" and said it is "no longer willing to shoulder the very disproportionate share of the burden."
The move was denounced over the weekend by - among others - UNRWA, Palestinian leaders, the European Union and Jordan, which has a significant Palestinian population.
Germany announced a "substantial" increase to its existing $94 million donation to UNRWA but said it would not make up the $217 million the agency needs to continue services this year.
The EU - UNRWA's second biggest donor - urged the US to reconsider its "regrettable" move.
Jordan said it would continue to rally donor support. Foreign Minster Ayman Safadi said: "Disruption of UNRWA services will have extremely dangerous humanitarian, political and security implications for refugees and for the whole region. It will only consolidate an environment of despair that would ultimately create fertile grounds for further tension."
After the US announcement, UNRWA'S Commissioner-General Pierre Krähenbühl paid tribute to donors who have stepped up in recent months to help.
He said 25 countries had advanced their donations, 30 donors had provided additional contributions and some had signed multi-year agreements.
But he said there was still a "critical need" for more than $200 million if UNRWA is to survive this year's crisis.
Krähenbühl said: "When we opened the school year on time this week - with the admirable support of our partners, it was a moment of celebration, pride and hope.
"UNRWA does not pay lip service when it comes to the right to education, to empowering young girls, to developing critical thinking and teaching tolerance and human rights. There is nothing artificial in our commitment to the preservation of opportunities and rights."
UNRWA provides aid to more than three million out of the five million Palestinians registered as refugees, through its schools and health centres.
Schools in Gaza and the West Bank reopened last week, while those in Lebanon, Jordan and Syria welcomed back students at the weekend.