The lymphoid tyrosine phosphatase LYP, encoded by the PTPN22 gene, recently emerged as a major player and candidate drug target for human autoimmunity. The enzyme includes a classical N-terminal protein tyrosine phosphatase catalytic domain and a C-terminal PEST-enriched domain, separated by an approximately 300-amino acid interdomain. Little is known about the regulation of LYP. Herein, by analysis of serial truncation mutants of LYP, we show that the phosphatase activity is strongly inhibited by protein regions C-terminal to the catalytic domain. We mapped the minimal inhibitory region to the proximal portion of the interdomain. We show that the activity of LYP is inhibited by an intramolecular mechanism, whereby the proximal portion of the interdomain directly interacts with the catalytic domain and reduces its activity.