The former Inter Milan coach joined Watford on a three-year contract last year, replacing Quique Sanchez Flores, and guided the club to Premier League safety this season.
"After the Board discussed with Walter Mazzarri the club's future goals and aspirations, it was decided he will be stepping down from his position as the club's Head Coach after the final game of the 2016/17 season," Watford said in a statement.
"We thank Walter and his staff for the contribution they have made to Watford Football Club over the past year."
Mazzarri began his coaching career in Italy's lower leagues in 2001, taking Livorno into the top flight in 2004 before keeping Reggina in Serie A for three seasons.
The Italian guided Sampdoria to a sixth-place finish in 2008, qualifying for the UEFA Cup, and they were runners-up in the Coppa Italia the following season after losing to Lazio.
He then led Napoli to Coppa Italia success in 2012 and a second-place Serie A finish the following season.
Mazzarri joined Watford after a spell on the sidelines following his sacking by Inter in November 2014 after a disappointing 18-month spell in charge, but things did not go according to plan in England.
Watford secured their safety a few weeks ago, but results have dipped alarmingly since they reached 40 points for the season. The team are currently 16th in the table, having lost their last five games.
Mazzarri was the eighth head coach to work under Watford's Italian owner Gino Pozzo, whose family took over the club in 2012.
(Reporting by Simon Jennings in Bengaluru; editing by Mark Heinrich)
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