Selectors ran out of patience with Khawaja after the left-hander averaged 20.33 in six innings in the series while squandering a number of promising starts.
Khawaja makes way for Smith, who missed the third test after being felled by a short ball from Jofra Archer during the second match at Lord's.
Smith's return is a timely boost for Australia, who need only win one of the final two matches to retain the Ashes.
The series is tied at 1-1 after England claimed a tense one-wicket win at Headingley courtesy of a brilliant, unbeaten century by Ben Stokes on the final day.
Australia all-rounder Marnus Labuschagne, who replaced Smith as a concussion substitute at Lord's, has been retained after scoring twin half-centuries in the defeat at Headingley.
Labuschagne is expected to bat at number three, with Smith to return to his favoured number four slot.
Paceman James Pattinson has been dropped, paving the way for Mitchell Starc's recall after his seven-wicket haul in the tour match against Derbyshire.
Starc, the top wicket-taker with 27 victims at the recent one-day World Cup in England, is expected to vie with Peter Siddle for the third seamer spot, with Pat Cummins and Josh Hazlewood expected to be retained at Old Trafford.
Marcus Harris, who replaced out-of-form opener Cameron Bancroft for the third test, has also been retained and given another chance to cement his place at the top of the order with David Warner after he managed eight and 19 at Headingley.
Siddle, who took five wickets across the first two tests before being rested at Headingley, said the pitch looked "pretty similar" to past wickets at Old Trafford, with something early for pacemen and spin likely to be a factor late on.
"Both teams will be looking to make the most of that (turn) later on in the game," he said in a Cricket Australia podcast.
"The first two, three days there is always a bit of seam around. Fast bowlers have had a lot of success up here also.
"I think it's just a good cricket wicket."
