The two bodies said on Wednesday that the city missed a May 14 deadline to underwrite a $US135 million ($155.85 million) renovation that would create a 68,000-capacity venue for the finals.
Talks will now start to find another way of including Brazil's largest city in the 12-venue 2014 finals.
"FIFA and the (local organising committee) will engage with the city of Sao Paulo for further discussions," FIFA said in a joint statement.
The 50-year-old Morumbi stadium, home of Sao Paulo FC, was intended to host group stage and second-round matches plus a semifinal. It is also scheduled for use in the Olympic tournament when Rio de Janeiro hosts the 2016 Summer Games.
However, the remodelling project had been plagued by delays and criticised by FIFA.
FIFA secretary general Jerome Valcke said last month it was "amazing" that Brazil's planning for the finals had fallen so far behind schedule.
"I got a report on the status quo of the Brazilian stadiums," said Valcke, who repeatedly denied that the Morumbi's World Cup status was in jeopardy.
"There are a number with red lights already, which is amazing. And I am not just talking about Morumbi or Maracana stadiums. I am talking about a number of stadiums," he said.
"The stadiums are the basic points we need to have a World Cup and in Brazil, for the time being, most of the deadlines are already over and we have to work on new deadlines."
FIFA awarded the 2014 hosting rights to Brazil in October 2007 after declaring the race open only to South American countries.
Brazil was the sole candidate, although it already was a strong favourite even before Colombia withdrew several months before the scheduled decision by FIFA's ruling executive.