Garcia agreed in principle to the deal, worth approximately $4 million plus incentives, on Nov. 26. A physical examination and the finalization of contract language held up an official confirmation.
"I feel really good about Freddy coming back," manager Joe Girardi said. "I loved what Freddy did for us last year. He's a different look from a lot of our guys, which I think is important when you have a rotation."
Garcia can earn more than $1.5 million in additional incentives. He will earn a bonus of $250,000 if he makes 25 starts, and would hit additional incentives of $250,000 each if he makes 27, 29 and 30 starts. He can earn an extra $275,000 for his 31st start of 2012, and $300,000 for a 32nd start.
Relying on his experience to make the most of a soft-tossing style, the 35-year-old Garcia earned a base salary of $1.5 million last season, when he attended Spring Training on a Minor League contract.
He went 12-8 with a 3.62 ERA in 26 games (25 starts) in his first season in the Bronx, completing 146 2/3 innings and starting Game 2 of the American League Division Series against the Tigers.
In order to make room on the Yankees' 40-man roster, outfielder Colin Curtis was designated for assignment.
Garcia figures to help fill out a rotation that is projected to be headed by ace CC Sabathia, and also include right-handers Ivan Nova, Phil Hughes and A.J. Burnett.
Other options -- such as Hector Noesi, Dellin Betances and Manny Banuelos -- are expected to challenge for attention in camp.