The Hornets will hold an official renaming ceremony towards the start of the next campaign, with other associated items around the ground to be changed throughout the close-season.
Hornets chief executive Scott Duxbury told the club’s website: "It's always been our intention to honour one of the club's greatest servants and renaming the Rous Stand is hugely appropriate.
"We intend to permanently reserve two seats, for Graham and his wife Rita, within the directors' seating area in a stand which already contains The Sir Elton John Suite.
"Both men are synonymous with a special time in the club's history, so we feel this is a fitting tribute."
Taylor said: “I feel truly honoured that Watford would seek to recognise my time at the club in this way.
“As everybody is very well aware, I spent a big part of my working life at the club and as part of the town and its community.
“What we created, among the success on the field of play, was a very special feeling – the memories of which have always remained with me.
“It will certainly feel strange coming to future Watford home matches and sitting in a stand named after myself, although it’s something that myself and my family can take immense pride in. So I would [like to] thank everyone at the club most sincerely for this wonderful gesture.”
Taylor first became Watford manager in 1977 and famously led the club to the old first division with three promotions in the space of five years.
The Hornets finished runners-up in their first season in the top-flight to qualify for Europe and reached their only FA Cup final to date in 1984.
The Hornets boss left to join Aston Villa in 1987 but after becoming England manager and then taking over at Wolves, he returned to Watford in 1996.
Taylor was unable to stop the Hornets from being relegated to the third tier but after a year as general manager, he again assumed the hot seat and guided the club to back-to-back promotions, with their elevation to the Premier League achieved via play-off glory at Wembley.