The 59-year-old, who has signed a three-year deal, had been out of the game since leaving Aston Villa at the start of last season.
He takes over with the club sitting 16th in the 20-team table, with 11 points from 13 games.
O'Neill, who captained Northern Ireland at the 1982 World Cup finals, joins a club he supported as a boy and will hope to quickly turn their fortunes around.
The Black Cats have won only two of their league games this season to sit two points above the relegation zone.
Assistant manager Eric Black will be in charge of the team for Sunday's tricky trip to fellow strugglers Wolverhampton Wanderers before O'Neill takes full charge.
"It's a very nice feeling to be back in football and to be the manager of Sunderland. It's a big moment for me," he said in a statement.
"I'd heard about what a good club it was but coming here, seeing the stadium and training ground, I've been bowled over. It's absolutely fantastic.
"I hope I can help Sunderland to a very successful period. That's what I've come for and that's my driving ambition."
O'Neill's arrival at the Stadium of Light comes nearly 16 months after his sudden departure from Aston Villa five days before the start of the 2010/11 season.
He gave no reason for his shock resignation but it came at a time when he was having to deal with constant media speculation over the possible sale of some top players.
O'Neill, who spent much of his playing career at Nottingham Forest where he won the 1979 and 1980 European Cup, ruled himself out of the running for the Northern Ireland job in October saying he was considering a return to club football.
He took Leicester City into the Premier League in 1996 and steered them to two League Cups before joining Celtic where he won three Scottish league titles as well as four domestic cups and a place in the 2003 UEFA Cup final before taking charge at Villa.
His four-year tenure at the Midlands club included three sixth-place finishes in the Premier League and Villa's first final in a decade - a League Cup defeat by Manchester United in 2010.
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