Small had asked for a raise to $1.45 million when the two sides exchanged arbitration numbers last week. The Yankees countered with $1.025 million.
In addition to his base salary, Small could earn $80,000 in performance bonuses: $15,000 each for 15 and 20 starts, and $25,000 each for 25 and 30 starts.
Small made $149,180 last season after he was brought up from the Minor Leagues on July 17. The most he ever made in a season before this year was $197,500 in 1998.
"It took several conversations," said general manager Brian Cashman. "But anytime you can keep these things out of the arbitration arena, that's preferred."
Small compiled a 10-0 record in the regular season, helping New York capture an eighth consecutive American League East title.
The 34-year-old journeyman started the 2005 season in the Yankees' Minor League system, going 1-4 with a 4.96 ERA in 11 games with Triple-A Columbus. Small was called up after the All-Star break to help fill some holes in the Yankees' banged-up rotation. After making his Yankees debut on July 20, he went back and forth from the bullpen to the rotation, filling in where necessary.
On Sept. 29, Small defeated the Orioles at Camden Yards, completing a perfect 10-0 season. Small became just the fourth pitcher in big league history to win at least 10 games without a loss, joining Tom Zachary, Dennis Lamp and Howie Krist.
In Small's nine starts, the Yankees were 8-1, though he is expected to fill a long-relief role in the bullpen this season if the rest of the rotation is healthy.
The only other Yankees player eligible for arbitration is Shawn Chacon, who earned $2.35 million in 2005. Chacon asked for $4.15 million for the 2006 season, while the Yankees countered with an offer of $3.1 million.
"We got Small settled," said Cashman. "I have Shawn Chacon to focus on now."
Chacon went 7-3 with a 2.85 ERA in 14 games (13 starts) for the Yankees after being acquired from the Rockies before the trade deadline. The 28-year-old held opponents to a .225 batting average with the Yankees, allowing three runs or fewer in 10 of his starts.
Mark Feinsand is a reporter for MLB.com. The Associated Press contributed to this report. This story was not subject to the approval of Major League Baseball or its clubs.