Smith will sign on a two-year contract following his release by Newcastle, despite Alan Pardew suggesting he would like the former England international on his coaching staff.
MK Dons statement: "The former Manchester United and England star was a huge hit with the fans during his loan period with the club last season and always expressed his desire to stay at stadiummk.
"After battling against a number of other clubs for Smith's signature, Karl Robinson will be delighted at sealing the permanent signing of his number one summer target."
The 31-year-old had a six-year spell at Leeds which saw him score 56 goals in 228 appearances.
Smith made a controversial switch to Manchester United for a £7million transfer fee in 2004, following Leeds' relegation from the Premier League.
During his three years at Old Trafford Smith won the Premier League title and the Carling Cup, but his time with the Red Devils was marred by an horrific broken leg and dislocated ankle sustained in an FA Cup tie against Liverpool in 2006.
Smith made the switch to Newcastle in August 2007, signing for an undisclosed fee, but never reached the heights of performance again following that injury.
YOUTUBE VIDEO: http://www.youtube.com/watch?v=Mth6_xSIw5M
Source: FOOTYMAD
