The 33-year-old midfielder had been tipped to reunite with Chelsea manager Jose Mourinho after his contract expired following Atletico's triumphant 2013-14 campaign.
However, Tiago has decided to remain in Madrid - a big boost for Diego Simeone, who has already lost leading scorer Diego Costa (Chelsea), David Villa (New York City), Filipe Luis (Chelsea) and loanee Thibaut Courtois (Chelsea) among others.
Speaking to Atletico's official website, the Portuguese veteran admitted he was close to ending his stay at the Vicente Calderon but opted to renew as the club prepare to defend their league title.
"I felt proud because we'd had an incredible season, but I thought it was time to close a cycle," said Tiago, who first arrived at Atletico on loan from Juventus in 2010-11.
"I had the opportunity to play in various international leagues and I took some time to assess the various options during the summer, but at the time of taking the final decision, it was clear to me that Atleti was the only right choice.
"During these weeks many false things have been said about me, but that doesn't change anything. Since the season ended, I had not completely forgotten Atleti nor had the club completely forgotten about me.
"The Cholo always left the door open for me and now I'm very happy because I know that I've made the right choice.
"I want to thank the club very much for waiting for me and for offering me the opportunity to stay here. I look forward to helping the team in everything I can."
Tiago will now link up with his team-mates at Atletico's pre-season training camp in Segovia before the club open their competitive campaign against city rivals Real Madrid in the first leg of the Supercopa de Espana on August 19.
