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Prime Minister Tony Abbott announced on Sunday Australia had received a specific request from the US government to contribute forces to possible military action in Iraq.
Cabinet and its national security committee met on Sunday to discuss the matter.
"The government has decided to prepare and to deploy to the United Arab Emirates a military force," Mr Abbott told reporters in Darwin.
Australia's contribution will include up to eight Super Hornet combat aircraft, an early warning and control aircraft and aerial refuelling aircraft.
A contingent of Special Forces will be sent to potentially act as military advisers to Iraqi and other security forces.
Four hundred air personnel and about 200 military personnel will be involved in the deployment.
Mr Abbott said "air elements" would depart in the next week or so while "military elements" could leave sooner.
"We think this is a balanced and proportionate contribution to what is our fight, but it is the world's fight," he said.
The prime minister emphasised that Australia was part of an international coalition and the deployment did not mean Australia was at war.
The deployment was not a commitment to combat operations in Iraq.
"But obviously that's something we have in contemplation," he said.
The move comes days after US President Barack Obama ordered a "relentless" war against Islamic State, including air strikes in Syria and expanded operations in Iraq to "destroy" the jihadists.
Mr Abbott warned Australia's involvement in the conflict could last many months rather than weeks.
His announcement came hours after the Islamist group released a video purportedly showing a masked militant killing British aid worker David Haines, who was taken hostage in Syria in March 2013.
Mr Abbott's reaction to the beheading - the third in recent weeks - was one of "shock, horror, outrage and fury".
"The evil and exaltation in evil that was yet again on display today, should make all of us more resolved than ever to do whatever we reasonably can to disrupt, degrade and if possible destroy this movement," he said.
He was not aware of any Australians being held hostage by IS terrorists.
On Friday, Australia lifted its terror alert level from medium to high, but the government has stressed that did not mean an attack was imminent.
There are at least 60 Australians fighting with IS and a further 100 supporting extremist groups.
The prime minister rejected suggestions Australia's growing involvement in Iraq would make it a target.
"These terrorists and would-be terrorists are not targeting us for what we have done, or for what we might do, they are targeting us for who we are, they are targeting us for our freedom, our tolerance, for our compassion, for our decency," he said.
Chief of the Defence Force, Air Chief Marshal Mark Binskin, said disrupting IS would take a "comprehensive and sustained effort".
"If we do nothing, the risk of allowing the shocking acts of ISIL to further destabilise the Middle East, and spread beyond the Middle East region, potentially back to Australia is a greater risk," he said.
