The 37-year-old Dutchman, who played for the Serie A giants from 2002 until 2012, has replaced Massimiliano Allegri, who was sacked on Monday after a poor start to the season.
Seedorf had been playing for Botafogo in Brazil but announced on Tuesday he was ending his 22-year playing career to take up the role at his former club.
"You can't say that I'm back as I never really left," he said.
"We have a lot to do to get the club back where it belongs and I'm very happy to be back here.
Clarence Seedorf factfile
Clubs: Ajax (1992-95); Sampdoria (1995-96); Real Madrid (1996-2000); Inter (2000-02); Milan (2002-2012); Botafogo (2012-2014)
International caps: 87
"At the moment, I feel very emotional and I also feel a sense of duty. I have to give 100% to rebuild, and to give enthusiasm and a sense of security. We can look to do important things for the fans. I left Milan in May 2012 at the end of a cycle. My job now is to open a new one."
Milan are currently 11th in the Italian top flight, and 30 points behind leaders Juventus.
Allegri's sacking came after Milan lost 4-3 to minnows Sassuolo on Sunday.
Former Netherlands international Seedorf made more than 400 appearances for Milan, helping them win two Serie A and two Champions League titles.
He was also the first player to win the Champions League with three different clubs - Dutch side Ajax in 1995, Spanish giants Real Madrid in 1998 and Milan, in 2003 and 2007.
He has also played for Inter Milan and Sampdoria.