Dominant mutations in the Arabidopsis PHABULOSA (PHB) and PHAVOLUTA (PHV) transcription factor genes cause transformation of abaxial to adaxial leaf fates by altering a microRNA complementary site present in processed PHB and PHV mRNAs but not in the corresponding genomic DNA. phb-1d mutants accumulate excess PHB transcript throughout the leaf primordium, indicating defective regulation of PHB transcript synthesis and/or stability. We show that PHB and PHV coding sequences are heavily methylated downstream of the microRNA complementary site in most wild-type plant cells and that methylation is reduced in phb-1d and phv-1d mutants. Decreased methylation is limited to the chromosome bearing the dominant mutant allele in phb-1d heterozygotes. Low levels of methylation are detected in wt PHB DNA isolated from undifferentiated tissues. These results suggest a model in which the microRNA interacts with nascent, newly processed PHB mRNA to alter chromatin of the corresponding PHB template DNA predominantly in differentiated cells.