Negotiations to form a grand coalition - known as GroKro in German - have dragged on far longer than expected as the two sides worked to iron out the details about the composition of the next German government.
Media reports said Schulz, a former European Parliament chief, was now set to take over the foreign ministry and would give up the party chairmanship in return.
The deal also sees Mrs Merkel's party lose the interior brief to its Bavarian sister party the Christian Social Union (CSU).
SPD members will decide on whether to accept the coalition agreement.
The coalition treaty puts Europe front and centre, with the parties agreeing to support the ambitious European Union reform drive of French President Emmanuel Macron to give the bloc "a new start". The SPD's 4,60,000 members will vote in the coming weeks on whether to agree to a coalition government with the CDU and CSU.
It's not the first time Merkel's party, the CDU/CSU, has entered into a coalition with the SPD, and many in the party believe that re-entering a coalition with the chancellor's Christian conservatives would be damaging in the long term, reported the BBC.
"Ultimately the CDU secures the prize of a fourth term for Merkel" says Carsten Nickel, managing director at Teneo Intelligence.
Ms Merkel has been leading a caretaker government since October, which works for day-to-day business but means Germany has not been able to launch major initiatives or play a significant role in the debate on the future of the EU.
Their leader Martin Schulz had initially ruled out working with her in the next four years, preferring to sharpen the SPD's profile in opposition.
Mrs Merkel has been fighting to stay in power since suffering damaging losses in September's elections.
The left-of-centre Social Democrats (SPD) claimed the prized finance portfolio in a new grand coalition deal settled on Tuesday, a ministry that will be key to driving reforms in the European Union's single currency eurozone. The results from that are due in early March, and that vote is now looking too close to call either way.
Leaders will go before the press in the early afternoon to present their coalition agreement, which stalled on bad-tempered disagreement on health and labour reform. The coalition's answer to the AfD's strident opposition to immigration is a cap on refugee admissions of 180,000 to 220,000 a year - far below the approximately some 1 million who arrived in 2015.
The EU is more likely to succeed "when Paris, Brussels and Berlin are pulling together", said Moscovici, adding that there were "common concepts" between the three capitals.
An Insa poll on Monday showed mounting pressure on Schulz, with support for the SPD dropping to just 17%, well below its election result of 20.5%, the party's worst since Germany became a federal republic in 1949.