Inhibitor 2 is a heat-stable protein that complexes with the catalytic subunit of type-1 protein phosphatase. The reversible phosphorylation of Thr 72 of the inhibitor in this complex has been shown to regulate phosphatase activity. Here we show that inhibitor 2 can also be phosphorylated on tyrosine residues. inhibitor 2 was 32P-labeled by the insulin receptor kinase in vitro, in the presence of polylysine. Phosphorylation of inhibitor 2 was accompanied by decreased electrophoretic mobility. Dephosphorylation of inhibitor 2 by tyrosine phosphatase 1 B, restored normal electrophoretic mobility. Phosphotyrosine in inhibitor 2 was detected by imrnunoblotting with antiphosphotyrosine antibodies and phosphoamino acid analysis. In addition, following tryptic digestion, one predominant phosphopeptide was recovered at the anode. The ability of inhibitor 2 to inhibit type-1 phosphatase activity was diminished with increasing phosphorylation up to a stoichiometry of 1 mole phosphate incorporated/mole o f inhibitor 2, where inhibitory activity was completely lost. These data demonstrate that inhibitor 2 can be phosphorylated on tyrosine residues by the insulin receptor kinase, resulting in a molecule with decreased ability to inhibit type-1 phosphatase activity.