The report by the Foreign Relations Committee puts new pressure on a delicate diplomacy between Washington and Baghdad to decide what future role American troops will have in Iraq - if one at all - before they start withdrawing this summer.
At least 159 Iraqi citizens and 100 police and soldiers were killed in insurgent attacks in January - the deadliest month for Iraq since September, according to data released Tuesday by security and health ministry officials in Baghdad.
An Associated Press count of Iraqis killed in attacks over two weeks alone puts the death toll at more than 200.
"The situation in Iraq is at a critical juncture," concluded the report, issued a few hours before Ambassador to Iraq James F. Jeffrey and Army Gen. Lloyd Austin, commander of the U.S. military in Iraq, testified before the Democratic-led Senate panel.
"Terrorist and insurgent groups are less active but still adept, the Iraqi army continues to develop but is not yet capable of deterring regional actors, and strong ethnic tensions remain along Iraq's disputed internal boundaries," the report said. "Although a government has finally been formed, it remains to be seen how cohesive and stable it will be."
The report mostly focuses on protecting the U.S. Embassy in Baghdad and its four satellite offices around Iraq after the planned Dec. 31 withdrawal, a deadline required under a security agreement between the two countries.
Jeffrey and Austin offered a relatively upbeat assessment about the transition in Iraq from a military mission to a civilian-led effort. They cited progress among security forces, greater stability in the newly formed government and increased oil production that will generate revenue.
"By the time we draw down our forces they'll have a pretty good capability to address internal security," Austin told the committee.
Questioned about Iraq through the prism of the push for greater democracy in Egypt, Jeffrey said Iraqis "believe in a democratic system. This has become part of the ethos of this country." Jeffrey, who had been in Iraq in 2003-04, said Iraq considers itself ahead of other countries in the Mideast in the move toward democratic rule.
Jeffrey and Austin indicated, however, that it will be a while before Iraq can defend itself from outside forces.
"While the Iraqi security forces have a good capability to confront Sunni and Shia extremist groups, they will have gaps in their external defense capabilities in 2012. Iraq will not be able to defend its air sovereignty for some time," Austin said.
Sen. John Kerry, D-Mass., chairman of the committee, called Iraq "our new forgotten war."
"While Afghanistan and Iran and now Egypt continues to demand our attention, Iraq's importance to the long-term stability of the Middle East cannot be underestimated," Kerry said.
The report looks at a compromise plan between a full military withdrawal and keeping combat forces in Iraq, which Prime Minister Nouri al-Maliki has signaled he will not permit.
Such a compromise could assign a robust military staff to the Embassy's security office that officials in Baghdad and Washington have said could house as many as between 100 and 800 soldiers. But that plan also has drawbacks, the report said, noting that "though such a force would have little interaction with the Iraqi public, it might also be cited as evidence that the United States has no intention of leaving Iraq."
In an unrelated interview this week, U.S. Lt. Gen. Robert Cone, a deputy force commander in Iraq, said he is unaware of any plans for the military to stay beyond 2011. "It is our policy to withdraw by December 2011," he said.
Violence is down from the widespread tit-for-tat sectarian killings that brought Iraq to the edge of civil war just a few years ago. But deadly bombings and shootings in Iraq still occur on a near-daily basis.
An almost daily barrage of bombings in January lasting almost two weeks - mostly targeting Shiite pilgrims and security forces - made it the bloodiest month in Iraq since September.
Austin said al-Qaida used the pilgrimage as an opportunity for violence. He said some 9 million pilgrims made the trek compared to 3 million last year, reflecting a greater sense of security among Iraqis.
The Senate report suggests that U.S. military and Iraqi leaders alike want American combat troops to remain beyond 2011 but acknowledges political pressures in both nations that would make that hard, if not impossible.
But the report concluded that too many lives have been lost - more than 4,400 soldiers alone - and more than $750 billion spent to abandon U.S. hopes of forging a long-term diplomatic relationship with Iraq.
Jakes reported from Baghdad.