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The 45-year-old former England international replaced the axed Andre Villas-Boas on an 18th-month deal in December but the short-term nature of his contract meant his position was subject to constant speculation.
Sherwood, whose final game in charge was a 3-0 league win at home to Aston Villa on Sunday, guided Spurs to a sixth-placed finish in the Premier League, ensuring the north London club's qualification for next season's Europa League.
But that wasn't enough to convince the Spurs' hierarchy he was the right man to take the team into the top four of the Premier League and so gain a place in the elite European Champions League.
"We appointed Tim mid-season as someone who knew both the players and the club," said Tottenham chairman Daniel Levy in a statement.
"We agreed an 18-month contract with a break clause at the end of the season and we have now exercised that option."
"Since appointing Tim as assistant first team coach in 2008 and then as technical co-ordinator in 2010 and head of football development in 2012, we have been supportive of him during football management changes throughout that period.
"On behalf of the club, I should like to state our thanks for all his efforts during his years with us. We wish him great success in his managerial career."
Levy added: "Moving forward, now the season is over, we shall embark on the process of finding a new head coach. We have a talented squad and exciting young players coming through.
"We need to build on this season, develop our potential and inspire the kind of performances that we associate with our great club."
Ajax's Frank de Boer and Southampton's Mauricio Pochettino have both been linked with the manager's job at White Hart Lane.
