A report released on Wednesday by the EU's executive body criticized Bulgaria's judiciary and prosecution process, and demanded that "sound financial management structures" be set up before the funds can be released.
"The Commission has taken the decision today to formalize this suspension [of aid] and withdraw the accreditation for two government agencies in charge of managing these pre-accession funds," Commission spokesman Johannes Laitenberger told a news conference on Wednesday.
European Commission President Jose Manuel Barroso said: "The Commission has also sent a strong signal today that EU funds must be managed properly."
Most of the funds for Bulgaria, which joined the 27-nation bloc last year, were part of a technical assistance program for acceding countries including aid for road-building, infrastructure, and agriculture.
If the two Bulgarian government agencies managing the EU funds fail to implement reforms and regain their accreditation by November, the 500 million euros in aid will be cancelled altogether.
The report, which had been toned down from an even harsher previous version, also voiced concern over alleged vote-buying at the local elections in November 2007 and June 2008, and demanded a full investigation.
In response to the findings, Bulgarian Prime Minister Sergey Stanishev said he was disappointed, but conceded that there was "a discrepancy between political will and concrete results." However, he said the country "has had some serious successes after one year of membership."
Bulgaria joined the European Union in January 2007 along with Romania. Both countries have been severely criticized by Brussels for their inability to tackle judicial reform, corruption and organized crime. However, the EU has stopped short of withholding funds to Romania.