U.S. Middle East envoy George Mitchell returns to the region next week to try to salvage indirect peace talks between Israel and the Palestinians. The Palestinians have said the process may be thwarted unless Israel cancels a plan announced this week to build 1,600 settler homes near Jerusalem.

Here are major issues on the table:

TWO-STATE SOLUTION

The Obama administration is pushing for an agreement that would create a state for the Palestinians in the West Bank and Gaza Strip alongside Israel, the so-called two-state solution at the core of U.S. efforts for an Israeli-Palestinian peace.

Israeli Prime Minister Benjamin Netanyahu has said a Palestinian state must be demilitarized so as not to threaten Israel. The Palestinians do not object to this demand, but say it should be discussed in negotiations with Israel.

ISRAELI SETTLEMENTS

Ahead of a final peace agreement that would determine the status of settlements Israel has built in the West Bank and East Jerusalem --- land it captured in the 1967 Middle East war --- Palestinian President Mahmoud Abbas has called for a total freeze of their expansion in line with a commitment Israel made under a 2003 U.S.-backed road map for peace.

Among other things, the road map also committed the Palestinian Authority to move against those planning or executing attacks on Israelis. Western powers say Abbas has improved Israel's security, but Israel says it is not enough.

Netanyahu announced in November a 10-month halt to new housing starts in West Bank settlements. He did not apply the measure to East Jerusalem, also captured from Jordan in 1967.

Palestinians say all settlements should be evacuated, and along with the World Court and major powers, consider them illegal. Netanyahu has pledged to keep several major settlement blocs in any peace deal. Previous Israeli governments have said they could compensate by giving Palestinians land elsewhere.

JERUSALEM

Palestinians want East Jerusalem, which includes the Old City and its sites sacred to Muslims, Jews and Christians, to be the capital of the state they aim to establish in the West Bank and Gaza Strip. Netanyahu has said Jerusalem would remain Israel's indivisible and eternal capital. Israel's claim to Jerusalem is not recognized internationally.

REFUGEES

Palestinians have long demanded that refugees who fled or were forced to leave in the war of Israel's creation in 1948 should be allowed to return, along with millions of their descendants. Yet Palestinian negotiators have signaled they would accept a just and agreed-upon solution for refugees as laid out in a U.N. resolution that mentions compensation for those who settle elsewhere.

Israel says any resettlement of Palestinian refugees must occur outside of its borders.

(Jerusalem newsroom, Editing by Michael Roddy)

Israel