The Serie B club has announced the former Italy international as the new man in charge, making him the 11th appointment in two and a half years.
The Rosaneri were relegated from Serie A in the 2012-13 season following an 18th-place finish and have responded by hiring the former Italy international, who was part of the Azzurri side which lifted the World Cup in 2006.
Gattuso follows in the immediate footsteps of Giuseppe Sannino, although he is the 11th appointment for the position in two and a half seasons and the 20th appointment at the Stadio Renzo Barbera in seven years.
He has a limited amount of coaching experience having been promoted from player to player-manager at Sion in February this year, when he became the fifth boss of the 2012-13 season at the Swiss club.
Following his sacking on May 13, Gattuso was heavily linked with the Sicilian club and Palermo president Maurizio Zamparini revealed in early June that a verbal agreement was in place with the former defensive midfielder.
The 35-year-old enjoyed a profitable time at AC Milan during his playing career - having joined in 1999. He won two Champions League trophies, two Serie A titles and one Coppa Italia before leaving in 2012.
On the international stage, Gattuso won 73 caps for Italy and was named in the World Cup team of the tournament in Marcello Lippi's victorious 2006 squad.
The new Palermo boss will be presented to the media on Friday, with Luigi Riccio as his assistant in the 2013-14 season.