Magath, who led Wolfsburg to their only Bundesliga title in 2009 before joining Schalke 04, returned late in the 2010/11 season to rescue them from relegation.
"We want continuity and are on a good path with Felix Magath," said VfL boss Francisco Javier Garcia Sanz. "A year ago we were almost relegated and this season missed out on the Europa League spots on the last matchday."
Wolfsburg finished in eighth place this season thanks to a good run after the winter break.
"Now our job is to continue this work and develop it," said Magath. "We want to turn the VfL into a force in the Bundesliga."