The 18-year-old's future appeared to lie away from San Siro after his agent Mino Raiola told the club his client would not renew his deal.
But a post on Milan's official Twitter feed on Tuesday read: "#ACMilan and @gigiodonna1 have reached an agreement to extend the goalkeeper's contract through to 2021 #Gigio2021"
Donnarumma, seen as the long-term successor to Italy goalkeeper Gianluigi Buffon, has made over 70 appearances for the Rossoneri since his surprise breakthrough in October 2015 and many fine performances have attracted attention from high places.
He was linked with Juventus, Real Madrid and Manchester United after the initial announcement he would not extend his deal, which was due to expire next summer.
In quotes carried by La Gazzetta dello Sport on June 15, club director Marco Fassone told a press conference: "Mino Raiola has conveyed to me Donnarumma's decision not to renew. It's his final decision."
In his first outing at the European Under-21 Championship with Italy three days later, fans unhappy with the decision threw fake money at Donnarumma and displayed a banner reading "Dollarumma".
Later in June, though, he said he was "sorry this uproar has been created around me" and that "my future will be spoken about after the national team (commitments)".
And a statement on the club's website on Tuesday read: "In the end, the club and the goalkeeper have reached an agreement to extend Gianluigi Donnarumma's contract.
"This is positive news for AC Milan, who have worked hard to renew the keeper's contract, for the player and the fans.
"Gigio's experience in red and black continues. AC Milan will be holding on to one of the most talented players in the squad, who will be part of the backbone of the Rossoneri in the new season. Pure class and talent that will continue to defend AC Milan's goal ready to help the Rossoneri in the race for the Champions League."
