Simunic invoked a World War II-era slogan used by Croatia's then-puppet regime following a 2-0 playoff victory against Iceland last month.
"After taking into account all of the circumstances of the case, and particularly given the gravity of the incident, the committee decided to suspend the player for 10 official matches," FIFA said in a statement.
The incident is the latest to discredit football in Croatia, after UEFA President Michel Platini described its fans as the worst behaved at the 2012 European Championship.
The sanction also reflected FIFA's commitment this year to tougher sanctions for racism and discrimination at matches.
Croatia coach Niko Kovac, a teammate of Simunic at the 2006 World Cup, said the ban probably ended the 35-year-old defender's national team career.
"I'm unpleasantly surprised, shocked and disappointed by FIFA's ban of Simunic," Kovac said. "I'm primarily sad for Simunic who will miss the World Cup. I know him for long as a player and a person and I'm sure he did not want to offend anyone."
Kovac said the Croatian football federation would appeal to FIFA. If that fails, a challenge at the Court of Arbitration for Sport could follow.
Croatia hosted Iceland in Zagreb on Nov. 19 for a decisive qualifying match after a 0-0 draw in the first leg.
After the match, Simunic took a microphone on the pitch and shouted to supporters: "For the homeland!" The fans responded: "Ready!"
FIFA said Monday that the salute was "discriminatory and offended the dignity of a group of persons concerning ... race, religion or origin."
Simunic will miss the whole World Cup tournament in Brazil and is also barred from the stadiums where Croatia will play its next 10 games.
Simunic said he felt "bitter and shocked," according to Damir Vrbanovic, managing director of Croatia's football federation
"It is clear that FIFA wanted to send a strong message with this draconian punishment," Vrbanovic said.
FIFA also fined Simunic 30,000 Swiss francs ($33,800) and ordered the Croatia football federation to pay a fine of 70,000 Swiss francs ($78,700).
Simunic previously defended his action, saying he was driven by love for his country.
The Australia-born player famously was sent off at the 2006 World Cup against Australia after receiving three yellow cards.
In a separate FIFA disciplinary verdict Monday, Croatia star forward Mario Mandzukic was banned for just one World Cup match for a red-card challenge against Iceland.
Mandzukic will miss the tournament's opening match when Croatia plays host Brazil in Sao Paulo on June 12.
"We knew that Mandzukic will be punished and in that context we are happy it's a one-match suspension," Kovac said.
The FIFA panel imposed the minimum sanction on Mandzukic for serious foul play.
The Bayern Munich forward, who scored the opening goal minutes earlier, was sent off for stamping on Iceland midfielder Johann Gudmundsson's left knee.
Stojanovic reported from Belgrade, Serbia.