Protein Ser/Thr phosphatase 5 is a 58-kDa protein containing a catalytic domain structurally related to the catalytic subunits of protein phosphatases 1, 2A, and 2B and an extended N-terminal domain with three tetratricopeptide repeats. The activity of this enzyme is stimulated 4-14-fold in vitro by polyunsaturated fatty acids and anionic phospholipids. The structural basis for lipid activation of protein phosphatase 5 was examined by limited proteolysis and site-directed mutagenesis. Trypsinolysis removed the tetratricopeptide repeat domain and increased activity to approximately half that of lipid-stimulated, full-length enzyme. Subtilisin removed the tetratricopeptide repeat domain and 10 residues from the C terminus, creating a catalytic fragment with activity that was equal to or greater than that of lipid-stimulated, full-length enzyme. Catalytic fragments generated by proteolysis were no longer stimulated by lipid, and degradation of the tetratricopeptide repeat domain was decreased by association with lipid. A truncated mutant missing 13 C-terminal residues was also insensitive to lipid and was as active as full-length, lipid-stimulated enzyme. These results suggest that the C-terminal and N-terminal domain act in a coordinated manner to suppress the activity of protein phosphatase 5 and mediate its activation by lipid. These regions may be targets for the regulation of protein phosphatase 5 activity in vivo.