The 45-year-old, who was appointed as Andre Villas-Boas' replacement in December, had initially signed an 18-month contract but was fending off speculation about his future almost straight away.
Having led Spurs to a sixth-placed finish and qualifying for next season's Europa League, Sherwood leaves with an impressive win percentage of over 59 per cent but with heavy defeats to Manchester City and Chelsea the stand-out results of his spell.
In a statement on their official website, Tottenham chairman Daniel Levy announced they had decided to take the option to end Sherwood's contract a year early and will now begin to conduct a search for his successor.
"We appointed Tim mid-season as someone who knew both the players and the club. We agreed an 18-month contract with a break clause at the end of the season and we have now exercised that option," the statement read.
"Moving forward, now the season is over, we shall embark on the process of finding a new head coach.
"We have a talented squad and exciting young players coming through. We need to build on this season, develop our potential and inspire the kind of performances that we associate with our great club."
Sherwood becomes the 12th Barclays Premier League manager to lose his job since the start of the season, with Southampton boss Mauricio Pochettino the favourite to take charge at White Hart Lane.
Pochettino has refused to answer questions about the link to the Spurs hot-seat but announced following a final-day draw with Manchester United that he intends to hold sit-down talks with Southampton's board this week.
It emerged in April that Levy had been in contact with Ajax to enquire about the avaialility of their head coach Frank De Boer whilst the initial front-runner Louis van Gaal now looks set to take charge at Manchester United.
Having worked with the club's younger players, Sherwood has stated many times that he would never wish to return to his developmental role with Spurs.
When asked in his press conference ahead of their final game of the season against Aston Villa he revealed he was not confident he would be managing anywhere next year.
Known for speaking his mind, the former Norwich and Blackburn midfielder publicly criticised the commitment of his players after they slipped to an unispiring 4-0 defeat at Chelsea.
That followed a 5-1 home loss to eventual champions Manchester City and, after easing past Ukrainian outfit Dnipro, Sherwood's side were knocked out of the Europa League in the round of 16 with a 5-3 aggregate defeat to Benfica.
With seven summer signings all struggling to make a lasting impact in their first season at Tottenham, Sherwood also questioned the recruitment policy and insisted more young English players needed to be given the chance in the first team.
An impressive display in their last league game of the season saw them beat Aston Villa 3-0 and seal a return to the Europa League next season but the writing already appeared to be on the wall for Sherwood.
During his spell in charge Sherwood compared his position to that of a babysitter and a supply teacher and claimed constant talk of his future had an adverse effect on the squad.
Brazil midfielder Sandro, who fell out of favour under Sherwood, said last week that he expected to be working under a new boss while the approach to De Boer and constant link to the likes of Pochettino always suggested Levy was ready to make a change.
Sherwood, who has been installed as the bookies' favourite for the vacant Brighton head coach role after Oscar Garcia resigned following the Seagulls' 6-2 aggregate play-off semi-final defeat to Derby, told Sky Sports News how upset he was to have lost his job at White Hart Lane.
"It is obviously a massive wrench to leave a club of the stature of Tottenham Hotspur, a club very close to my heart," he said.