The fiery Scolari's departure came two months after his side won the Copa Brasil knockout tournament.
"In a meeting which took place this afternoon between the president, director of football and coaching staff, it was decided by mutual agreement to end the contract between Luiz Felipe Scolari and the club," said Palmeiras in a statement.
"Palmeiras thank the coach for his services, he is one of the greatest leaders the club has had in all of its history."
Scolari, usually known as Felipao (Big Phil) is seen as a possible replacement for Brazil coach Mano Menezes who, despite winning most of his games in his two years in charge, has failed to capture the public imagination in the run-up to the 2014 World Cup, which Brazil hosts.
Scolari, one of Brazil's most successful coaches, was previously in charge of Palmeiras from 1997 to 2000, when they won the Brazilian championship, Libertadores Cup and Copa Brasil.
He returned to the club in July 2010 but struggled to repeat that success, as they managed a modest 11th place in last season's Brazilian championship.
His departure came the day after a 3-1 defeat at Vasco da Gama left Palmeiras 19th in the 20-team championship with 24 points, seven adrift of 16th-placed Flamengo and safety. The bottom four teams go down.
Scolari performed an astonishing transformation in just over a year in charge of Brazil.
He took over in 2001 with the team in disarray and suffered a shock elimination by Honduras at the Copa America shortly afterwards.
However, a late surge propelled them to the 2002 World Cup and, despite low expectations, they went on to win their fifth world title.