The Irishman returns to Portman Road, where he spent four-and-a-half seasons between 2007 and 2010. Walters scored 32 goals in 146 appearances for the Championship club.
"There was interest last week and the owner (Marcus Evans) rang me up, so when someone that important at the club contacts you and shows an interest then it's a no brainer really," Walters told the club website.
"There was interest from other clubs but it was a no brainer.
"I still have a lot of friends in the area, still came down here regularly to see people, and I'm ready to go.
"The club's not in a great position but it's only early days. The signs are good and I'm ready to go.
"I could have stayed (at Burnley) and not played, tried to force my way into the team but that wasn't happening. I could have taken the easy street but that's not what I'm about, I'm still hungry to do well and impress."