Israeli officials said the wounded Israeli, who also has US citizenship, and soldiers at the scene returned fire, wounding the gunman, who was pursued by troops and captured.
The incident occurred as Israeli and Palestinian officials held US-backed talks in Egypt aimed at calming months of violence.
It took place in Huwara, where last month a gunman from the Hamas Islamist militant group opened fire on a car killing two Israeli settlers, also coinciding with a day when Israeli and Palestinian officials held de-escalation talks.
Settlers responded to last month's incident by torching houses and cars and killing one Palestinian in a rampage described by a senior army commander as a "pogrom".
Israel's ambulance service said it had treated a man shot in Huwara in Sunday's incident.
A paramedic, among the first to arrive at the scene, said on Israel Radio that one Israeli man was wounded as he sat in his car with his wife.
Israeli media reported the wounded man was a former US marine who now lives in a Jewish settlement in the West Bank where he is a security instructor.
The US ambassador to Israel confirmed a US citizen had been injured in the attack.
The embassy declined to provide further details.
Hamas, which governs the Gaza Strip and also has a presence in the West Bank, has denounced the Israeli-Palestinian de-escalation talks that took place last month in Jordan and on Sunday in Egypt.
It said Sunday's attack was a natural response to Israel's occupation although it stopped short of claiming responsibility.
The Hamas gunman held responsible for last month's attack was killed by Israeli forces during a raid on the refugee camp in the West Bank town of Jenin earlier this month.
The West Bank has faced a surge of confrontations, with near-daily military raids and escalating settler violence amid a spate of attacks by Palestinians.
Sunday's talks aimed to head off further incidents when the Muslim holy month of Ramadan begins later this week.
Over the past year, Israeli forces have made thousands of arrests in the West Bank and killed more than 200 Palestinians, including fighters and civilians while more than 40 Israelis and three Ukrainians have died in Palestinian attacks.
