The 39-year-old spent the second half of last season on loan at Selhurst Park from Blackpool and scored the goal that clinched the team a place in the Premier League.
And his decision to put pen to paper on a new deal ends weeks of speculation regarding the player's future.
Phillips netted the winner against former club Watford in May's Championship play-off final to gain Palace promotion to the Premier League.
"I am absolutely delighted, I loved my time here at the end of last season and was always hoping to have another chance to play in the top flight," Phillips said.
"It's unbelievable for me but I am really looking forward to it and hoping I can play a great part in the season ahead.
"Everyone I spoke to said to keep going as long as the fitness and hunger is there and that is certainly the case with me."