The bill, which will reach the Council of Ministers next week, stipulates that those entering the country illegally or overstaying their visa will no longer be tried or fined up to €10,000.
However, repatriation measures will remain in place. Prison sentences will also remain for those involved in smuggling illegal immigrants.
The bill is also part of the government's drive to reduce prison overcrowding and give migrants better protection against exploitation by black-market employers.
Illegal immigration was criminalized by Silvio Berlusconi's government in 2009, a move which has since been widely criticized for stigmatizing migrants and leaving them vulnerable to exploitation.
The bill has received backing from Democratic Party members and the Five Star Movement.
But Roberto Maroni, the president of Lombardy and member of the right-wing Northern League, was among the first to condemn the bill, taking to Twitter on Friday to warn Italy to “prepare for an invasion” of illegal immigrants.
Northern League leader Matteo Salvini has vowed to hold a referendum against the move.
“Can they not see what's happening in the world? It's crazy!” he wrote on Facebook.
But anti-mafia prosecutor Franco Roberto argued that it will help authorities identify human traffickers, adding that the current law “hinders investigations”.