Federer found his feet in the third set, dropping only four points on serve.
But Seppi kept his cool and completed the upset, leaving the crowd stunned.
"I just tried to enjoy playing on the centre court. It's not often I get the chance," Seppi said.
"It's never comfortable playing against Roger ... I was focused on my service games because I didn't have many chances on his serve.
"It was one of the best matches [of my career] for sure - I won against Roger."
The opening week is always expected to be a walk in Melbourne Park for Federer - a reputation well earned given he has reached at least the semifinals for 11 straight years.
In his past 54 clashes with top-10 opponents, Seppi had tallied just one victory. His record against Federer was 10 losses.
But Federer started sluggishly and from the moment he was broken to love in the first set, giving Seppi a 5-4 lead, it was clear something was amiss.
Federer was also broken late in the second set, needing a slice of luck to return to parity and force a tiebreak.
The 33-year-old's decisive winner came from a return that seemed to dance on the net for an eternity before bobbling over to Seppi's side.
Federer held a 4-2 and 5-3 lead in the tiebreak, but lost the final four points to make it a two-set lead for Seppi.
Federer still had every reason to feel somewhat upbeat.
On nine occasions he had won after battling back from two sets down.
In contrast, Seppi relinquished a two-set lead in his previous career highlight - a fourth-round fixture against Novak Djokovic at the 2012 French Open.
But Seppi was up to the task, seeing off a break point in his opening service game of the fourth set before holding his nerve in the tiebreaker.
- AAP