The 32-year-old held talks with Hibernian after being offered a pay cut to stay at Fir Park but he has opted to extend his second spell at the club.
The Australian hit 14 goals last season and formed a strong strike partnership with Louis Moult.
McDonald told the club’s official website: “I am so happy to be back at the club and can’t wait to get started again.
“There were a couple of serious offers on the table for me, but I always had it in my mind that Motherwell was a club where I love being, playing with players and a manager who I respect and supporters who have been very good to me.”
McDonald has followed Stephen McManus, Keith Lasley and Steven Hammell in signing new contracts and manager Mark McGhee’s priority now is to replace midfielder Stephen Pearson, who left for a second spell in India.
McGhee said: “Scotty is one of the best players in the country, so we’re naturally delighted he has chosen Motherwell over the other options he had.
“We can’t compete with some of the bigger sides in Scotland for cash, but Motherwell is a special club that draws people to it, particularly those who have been here for a period of time. It’s a welcoming, family environment that both players and staff enjoy.
“We have real competition in the goalkeeping, defensive and forward areas now. We are working hard on central midfield targets and hope to announce some new additions soon.”