The AP-2 transcription factor family is presumed to play an important role in the regulation of the keratinocyte squamous differentiation program; however, limited functional data are available to support this. In the present study, the activity and regulation of AP-2 were examined in differentiating human epidermal keratinocytes. We report that (1) AP-2 transcriptional activity decreases in differentiated keratinocytes but remains unchanged in differentiation-insensitive squamous cell carcinoma cell lines, (2) diminished AP-2 transcriptional activity is associated with a loss of specific DNA-bound AP-2 complexes, and (3) there is an increase in the ability of cytoplasmic extracts, derived from differentiated keratinocytes, to phosphorylate AP-2 alpha and AP-2 beta when cells differentiate. In contrast, extracts from differentiation-insensitive squamous cell carcinoma cells are unable to phosphorylate AP-2 proteins. Finally, the phosphorylation of recombinant AP-2 alpha by cytosolic extracts from differentiated keratinocytes is associated with decreased AP-2 DNA-binding activity. Combined, these data indicate that AP-2 trans-activation and DNA-binding activity decrease as keratinocytes differentiate, and that this decreased activity is associated with an enhanced ability to phosphorylate AP-2 alpha and beta.