Sherwood, 45, took over from Andre Villas-Boas in December and signed a deal to the end of the 2014-15 season.
“We agreed an 18-month contract with a break clause at the end of the season and we have now exercised that option,” said Spurs chairman Daniel Levy.
Southampton manager Mauricio Pochettino and Ajax boss Frank de Boer have been linked with the post.
Sherwood’s final game in charge was the 3-0 victory over Aston Villa on the last day of the Premier League season and he claimed afterwards that he would have earned a top-four spot had he been in charge for the whole season.
The ex-Spurs midfielder took over with the White Hart Lane outfit five points shy of the Champions League qualifying spots and ended the campaign 10 points adrift of fourth-placed Arsenal.
Sherwood had a top-flight win percentage of 59%, which is the best of any Tottenham boss in Premier League history, and sixth place was enough to get the club into next season’s Europa League.
But there had been speculation over his future during his spell in charge, with Tottenham having to deny claims from Ajax that they contacted the Dutch club over the availability of De Boer.
Tim Sherwood’s final news conference
Sherwood also claimed he felt like a “supply teacher”, with players being told by their agents he would not be at the club next season.
Sherwood, who won three England caps, joined Tottenham as a player in 1999 from Blackburn, where he won the Premier League in 1995.
He left White Hart Lane in 2003 and moved to Portsmouth but returned as part of the club’s coaching staff in 2008 under manager Harry Redknapp.
Sherwood was working as technical co-ordinator when chairman Levy asked him to look after the first team following the sacking of Villas-Boas.