The NCAA cited the school's "continued progress toward ensuring athletics integrity" in relaxing the scholarship losses that threatened to cripple the famed football program.
The action was based on the recommendation of former U.S. Sen. George Mitchell and endorsed by the NCAA Division 1 Board of Directors.
"While there is more work to be done, Penn State has clearly demonstrated its commitment to restoring integrity in its athletics program," Mitchell said. "The university has substantially completed the initial implementation of all the Freeh Report recommendations and its obligations to the Athletics Integrity Agreement, so relief from the scholarship reductions is warranted and deserved."
Penn State will be allowed to increase its scholarship number to 75 in 2014-15, 80 in 2015-16 and begin competing with the maximum 85 in the 2016-17 academic year.
NCAA President Mark Emmert handed down unprecedented sanctions in 2012 in the wake of one of college sport's worst scandals. Emmert, who sidestepped due process after receiving permission to act alone from his fellow presidents, imposed on Penn State a four-year bowl ban, a $60-million fine and a reduction of 10 initial and 20 total scholarships each year for four years.
The bowl ban and fine will remain in place. Penn State went 8-4 last year under first-year coach Bill O'Brien and is currently 3-1.