The plan calls for Israel to move more than 40 families from Migron to Adam, an existing settlement near Jerusalem.
Israel has pledged to remove some two dozen unauthorised outposts in the West Bank, including Migron, but so far has not taken action. Migron is considered a key test of Israel's willingness to remove the outposts.
Israeli defence officials said Prime Minister Ehud Olmert visited Adam yesterday and approved the proposal. Officials were expected to present the deal to the Supreme Court tomorrow, but it was unclear whether the hearing would be postponed.
Israeli human rights lawyer Michael Sfard said the proposal is unacceptable because it effectively creates a new settlement.
"The relocation process will take at least two years so this proposal does not solve the problem," said Sfard, who has been leading a legal battle to uproot Migron.
Israel tries to differentiate between the tiny unauthorized outposts and its more than 100 full-fledged settlements in the West Bank. The international community considers all construction in captured territory to be illegal.
Most of the outposts consist of a few trailers on West Bank hilltops, put up by hard-line Israeli settlers to prevent creation of a Palestinian state.
More than 100 of the outposts have been counted by the anti-settlement Israeli Peace Now movement, but Israel is committed to removing only about two dozen - the ones put up after March 2002.
Migron is one of the largest of the outposts, and includes a synagogue, ritual bath and nursery school. Palestinians say it is built on private Palestinian land.
Word of the plan comes a day after Israel announced that it would cut off funding for the outposts and crack down on extremist squatters.
Israel never formally decided to support outposts, but an official 2005 report found that successive Israeli governments have helped build and expand the squatter camps in violation of promises to the US.
