Terms of the deal weren't disclosed, but Baker told reporters it was comparable to his now-expired deal, reported to be worth $3.5 million.
Baker returns to the Reds after leading them to a National League Central championship, going 97-65 -- the second-best record in the NL.
But his team was eliminated by the San Francisco Giants in the NL Division series after taking a 2-0 lead in the best-of-five playoff.
"There's work left to be done," Baker said. "I didn't want to leave on a note that we still had work to do. It left a real pain in my heart to feel as I did at the end of the season this year."
"This is Dusty's team," Reds Chief Executive Bob Castellini added. "These fellas here are poised to go deeper and deeper in the season. To not bring Dusty back was out of the question."
Baker, 63, sat out 11 games last month after being diagnosed with an irregular heartbeat and then suffering a minor stroke.
Notable deaths of 2014 [PHOTOS]