The 32-year-old, who was put on an "illicit drugs testing" programme for a year, was also banned for six weeks in 2015 after pleading guilty to cocaine possession.
"We acknowledge the off-field issues that Karmichael has faced in the past," Waratahs coach Daryl Gibson said, welcoming Hunt to the team. "Today's decision is one that as a team and a business, we have not taken lightly.
"Karmichael has been very open and genuine with us about his off-field issues and his desire to turn things around, not only professionally but personally."
Hunt, who has six caps for the Wallabies, began pre-season training with the Waratahs on Monday, while flyhalf Bryce Hegarty moved the other way in a player-swap deal, the club added.
Former rugby league international Hunt promised to repay the faith shown in him by the Waratahs.
"It means a lot me that Daryl and the Waratahs have decided to give me another go, I'm ready to take this opportunity with both hands," Hunt, who returned to playing in the National Rugby Championship with Brisbane City towards the end of 2018, said.
"I've made mistakes. But the time away... provided me with the opportunity to reassess why I was making bad decisions and work through all of that with my family and my psychologists."
The Waratahs face the Wellington Hurricanes in their Super Rugby season opener on Feb. 16.
($1 = A$1.3945)
(Reporting by Rohith Nair in Bengaluru)
