The leaked documents are said to show Sigmundur David Gunnlaugsson and his wife owned a firm in the British Virgin Islands which held investments in Iceland's collapsed banks.
Thousands of demonstrators protested outside parliament in Reykjavik on Monday, throwing eggs, bananas and yoghurt and calling for him to stand down.
The opposition also called a vote of no-confidence in the government, saying Mr Gunnlaugsson's reported offshore dealings amounted to a major conflict of interest.
Ahead of the vote, agriculture minister Sigurdur Ingi Johannsson confirmed Mr Gunnlaugsson was standing down from the coalition government.
The Prime Minister had earlier requested President Olafur Ragnar Grimsson dissolve parliament and call early elections.
But Mr Grimsson refused, saying he wanted to consult the main parties before making a decision.
Mr Gunnlaugsson is the first casualty of the millions of papers, leaked from Panama-based law firm Mossack Fonseca and apparently showing the ways the rich and famous exploit secretive offshore tax regimes.
The papers allege Mr Gunnlaugsson and his wife set up a company called Wintris in the British Virgin Islands in 2007 with the help of Mossack Fonseca.
He allegedly sold his half of the company to his wife for $1 on 31 December 2009 - the day before a new law came in that would have required him to declare the ownership of Wintris as a conflict of interest.
Mr Gunnlaugsson has denied any wrongdoing, insisting his wife's overseas assets were taxed in Iceland and that he had put the interest of the public before his own financial dealings.
He also said the assets did not affect his negotiations with Iceland's creditors during the country's financial crisis.
But feeling the heat on Monday, Mr Gunnlaugsson stormed out of a media interview about the papers. He later apologised.
The fallout from the papers is being felt around the world, with numerous public figures, politicians, their friends and relatives reportedly named in the documents.
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