The Uruguayan federation have announced the 74-year-old coach leaves the dugout after 15 years in charge of the national team.
Tabarez had two stints at Cagliari in 1994-95, leading the side to ninth in Serie A, before he returned for for four games in 1999-00.
The Uruguayan was in charge of Milan in 1996-97, picking up four wins and three draws in his 11 games in charge of the Rossoneri.
Tabarez, who won the Copa Libertadores with CA Penarol in 1986-87, helped Uruguay to win the Copa America in 2011.
After a run of four consecutive defeats in the World Cup Qualifiers for Qatar 2022, leaving Uruguay one point behind Colombia at fourth with four games remaining, the AUF announced his departure from the position.
“The Executive Committee of the AUF informs that it has terminated the contract of Oscar Washington Tabarez and the other members of the national team staff,” the federation wrote in a statement.
“We emphatically manifest that this decision does not imply the non-recognition of Tabarez’s important contribution to Uruguayan football.
“We salute and acknowledge the important results obtained in these 15 years, which have once again placed Uruguay among the top of world football.
“We express our respect and recognition for the professionalism and dedication during this long process of work and the immeasurable bond that this fruitful stage leaves in the history of the national team.
“The Executive Committee of the AUF took this difficult decision under the current circumstances, with the near future compromise and the results that we all expect.”