Regulators of G protein signaling (RGS proteins) constitute a large family of G protein-binding proteins. All RGS proteins contain a conserved core domain that can accelerate G protein GTPase activity. In addition, many family members contain a unique N-terminal domain of unknown function. Here, we demonstrate that the RGS protein in yeast, Sst2, is proteolytically processed in vivo to yield separate but functional N-terminal and RGS core domain fragments. In whole cell lysates, the full-length SST2 product (82 kDa) as well as a prominent 36-kDa species are specifically recognized by antibodies against the C terminus of the Sst2 protein. Purification and chemical sequencing of the 36-kDa species revealed cleavage sites after Ser-414 and Ser-416, just preceding the region of RGS homology. Expression of a mutationally truncated form of the protein (C-Sst2) could not restore function to an sst2Delta mutant strain. In contrast, co-expression of C-Sst2 with the N-terminal domain (N-Sst2) partially restored the ability to regulate the growth arrest response but not the transcription induction response. Whereas the full-length protein was localized to the microsomal and plasma membrane fractions, the N-Sst2 species was predominantly in the microsomal fraction, and C-Sst2 was in the soluble fraction. Mutations that block proteasome or vacuolar protease function, or mutations in the cleavage site Ser residues of Sst2, did not alter processing. However, Sst2 processing did require expression of other components of the pheromone response pathway, including the receptor and the G protein. These results indicate that Sst2 is proteolytically processed, that this event is regulated by the signaling pathway, and that processing can profoundly alter the function and subcellular localization of the protein.