The Knesset session, which started last night to extend the duration of the law that makes family reunion difficult after marriages between Palestinians with Israeli citizenship and Palestinians in the occupied West Bank or the blockaded Gaza Strip, continued until morning.
The extension of the ban failed as it secured only 59 votes out of 120.
Two members of the ruling coalition's United Arab List party refrained from voting in favor of the law, while a member of Prime Minister Bennett's Yamina party voted against it.
The left-wing Meretz party in the Bennett-led coalition and the United Arab List, which represents Israeli Palestinians, have already announced that they would not support the law's extension.
The session was extended as the coalition's leaders held negotiations to discuss differences over the law.
After negotiations, the coalition partners reached a compromise agreement to extend the law for six months instead of one year and to grant citizenship to 1,600 Palestinian families.
The coalition has sent a new request to the Knesset's speaker, asking for a vote on simply extending the statute for six months.
However, the opposition rejected the proposal, claiming that the coalition's solution violated the law's annual regularity, and vowed to vote against it in order to embarrass the coalition government.
Since the adoption of the unification law in 2003, the Knesset has voted annually to extend it.
Adalah, the Legal Center for Arab Minority Rights in Israel, says the law prevents family unification between Palestinians who hold Israeli citizenship and Palestinian citizens who reside in the West Bank and Gaza, in addition to the countries that Israel considers an "enemy state," such as Syria, Lebanon, Iraq, and Iran.
Thousands of Palestinians have suffered as a result of the law, which the Israeli government claimed was enacted for security considerations. Palestinians considered the law "racist."
"This law is considered one of the most racist laws in the world, so it should be deleted immediately," Adalah said in a previous written statement.
"There is not a single country in the world that chooses to settle and reunify the husbands and wives of its citizens according to their national and ethnic affiliation, and by classifying them as an enemy," the statement said.