The Knesset said on its website that the bill sponsored by internal security minister Gilad Erdan passed its third reading "by a large majority".
While the workers themselves are already subject to arrest and imprisonment, the new legislation strikes at Israelis who employ them and those who transport them.
Erdan said in a statement that with the passage of the new law "the police can be expected to mount large-scale operations to seize illegal entrants and those who assist them."
Among its provisos are that the Israeli employer of a Palestinian who has entered the Jewish state without the obligatory -- and hard to come by -- permit, will face up to two years in prison.
That is in the case of one worker for a single day.
"Those who employ more than one illegal worker, or hire an illegal worker for more than 24 hours, will face up to four years of incarceration," the site said.
In the case of companies who regularly take on unlicensed Palestinian staff, they face fines of between 40,000 and 452,000 shekels ($10,550 and $119,000).
Since October 1, a wave of violence has killed 193 Palestinians, 28 Israelis, two Americans, an Eritrean and a Sudanese, according to an AFP count.
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Most of the Palestinians were killed while carrying out knife, gun or car-ramming attacks.
Others were shot dead by Israeli forces during clashes or demonstrations, while some were killed in air strikes on Gaza.
Many analysts say young Palestinians are fed up with Israeli occupation, while Israel blames incitement by Palestinian leaders and media as a main cause of the violence.
A government adviser told a Knesset committee on Sunday that of the attacks carried out in Israel, including Jerusalem, 44 percent were carried out by Palestinians in the Jewish state illegally.
Israeli police say the security forces are engaged in a two-pronged campaign to shut down underground West Bank arms makers and to keep out Palestinians who have not undergone the rigorous security checks carried out on applicants for entry and work permits.
Last Tuesday Israeli Prime Minister Benjamin Netanyahu decided on a package of measures to quell the violence, including completion of the unfinished security barrier between Jerusalem and the West Bank.
He also ordered the cancellation of Israeli work permits for relatives of Palestinian attackers and fast-track demolition of perpetrators' homes.
Israel has increased its efforts against unauthorised Palestinian labourers, arresting more than 400 workers and dozens of their Israeli employers last week alone, police said.