The team did not disclose terms of the contract, but league sources told ESPN's Chris Broussard that Sanders signed a four-year deal worth $44 million.
The 6-foot-11 Sanders had career-highs of 9.8 points and 9.5 rebounds last season. His 2.8 blocks per game ranked second in the NBA, and he had a stretch of 40 straight games with a block.
"Larry has developed into one of the top young defensive players in the league," Bucks general manager John Hammond said. "He is a very important part of what we are doing in Milwaukee."
Sanders, the 15th overall pick in the 2010 NBA draft, is considered part of the core for the retooling Bucks, who traded Brandon Jennings (17.5 points) to the Pistons last month for point guard Brandon Knight (13.1 points).
The Bucks finished 38-44 last season before being swept in the first round of the playoffs by the eventual reigning two-time champion Miami Heat. Former Hawks coach Larry Drew is now the new boss in Milwaukee.
Information from The Associated Press was used in this report.