Findings could embarrass Obama as he seeks to persuade Netanyahu to extend settlement building freeze, New York Times reports.

U.S. Treasury tax breaks have helped West Bank settlers to receive $200 million in tax-free funding from American donors, according to a report published in the United States on Tuesday.

Differences in U.S. and Israeli law means it is easier to fund illegal outposts through donations from New York than from Jerusalem, according to an investigation by the New York Times.

West Bank settlement of Ariel

West Bank settlement

Photo by: Tess Scheflan

An examination of public records in the United States and Israel pinpointed at least 40 American groups that have raised over $200 million in tax-deductible gifts for Jewish settlers in the West Bank and East Jerusalem over the past decade.

The findings could embarrass U.S. President Barack Obama, an outspoken opponent of Israel's settlement policies who is expected to use a Tuesday meeting with Prime Minister Benjamin Netanyahu to push for a continued freeze on Jewish building in the West Bank.

According to the Times report, lenient American tax regulations allow funds to flow to settlement outposts that are illegal under Israel law – as opposed to larger settlement blocks that receive money from the Israeli government.

The result is that it is easier to fund outposts from the United States than from Israel, which over a decade ago outlawed tax breaks for contributions to groups devoted exclusively to settlement-building in the West Bank.

U.S. tax law applies to all nonprofit groups and there are Palestinian organizations that also benefit from U.S. donations, as does the Free Gaza movement, whose controversial aid flotilla was stormed by Israeli commandos a month ago. Nine activists were killed in the raid.

But the flow of cash to settler groups is particularly awkward for the Obama administration as it mediates renewed peace talks between Israel and the Palestinians. Washington has refused to allow Israel to spend American government aid on settlements and some U.S. officials fear the consequences of being seen to fund them indirectly.

"It’s a problem,” one unnamed senior State Department official was quoted as saying, adding, “It’s unhelpful to the efforts that we’re trying to make.”

Daniel Kurtzer, the U.S. ambassador to Israel from 2001 to 2005, said the issue was an unspoken source of embarrassment for American diplomats.

“It drove us crazy,” Kurtzer told the Times. But “it was a thing you didn’t talk about in polite company.”

He added that while the private donations could not sustain the settler enterprise on their own, “a couple of hundred million dollars makes a huge difference,” and if carefully focused, “creates a new reality on the ground.”

Israeli military commanders are also angry that U.S. funds are going to extremists groups whose leaders have urged resistance to any attempt to evict them.

“I am not happy about it,” a senior military commander in the West Bank.