The announcement followed the unveiling of new U.S. Treasury rules on Monday aimed at curbing such deals. The merger would have allowed New York-based Pfizer to cut its tax bill by redomiciling to Ireland, where tax rates are lower.
A source familiar with the matter told Reuters on Tuesday that the deal would be terminated.
Pfizer said on Wednesday it would pay Allergan $150 million as reimbursement of expenses related to the deal.
Allergan said it would report first-quarter results by May 10, when it would also update on its plans to simplify its operations after the close of its $40.5 billion deal to sell its generic drug business to Israel's Teva Pharmaceutical Industries. The deal is expected to close by June.
While the new Treasury rules did not name Pfizer and Allergan, one of the provisions targeted a specific feature of their merger - Allergan's previous history as a major acquirer of other companies.
The collapse of what would have been the biggest-ever inversion deal allows Obama to claim a major victory in his last year in office.
Obama on Tuesday called global tax avoidance a "huge problem" and urged Congress to take action to stop U.S. companies from tax-avoiding deals.
Pfizer was concerned that any tweaks to salvage its deal with Allergan might have provoked new rules by the Treasury, the source had told Reuters.
This is not the first time that a tightening of U.S. inversion rules has caused a merger to unravel.
U.S. drugmaker AbbVie Inc abandoned its $55 billion takeover of Ireland-domiciled peer Shire Plc in 2014 after the Obama administration cracked down on inversions. AbbVie had to pay Shire a $1.6 billion break-up fee.