Protein-tyrosine phosphatases can exhibit stringent substrate specificity in vivo, although the molecular basis for this is not well understood. The three-dimensional structure of the catalytically inactive protein-tyrosine phosphate 1B (PTP1B)/C215S complexed with an optimal substrate, DADEpYL-NH2, reveals specific interactions between amino acid residues in the substrate and PTP1B. The goal of this work is to rigorously evaluate the functional significance of Tyr46, Arg47, Asp48, Phe182, and Gln262 in substrate binding and catalysis, using site-directed mutagenesis. Combined with structural information, kinetic analysis of the wild type and mutant PTP1B using p-nitrophenyl phosphate and phosphotyrosine-containing peptides has yielded further insight into PTP1B residues, which recognize general features, as well as specific properties, in peptide substrates. In addition, the kinetic results suggest roles of these residues in E-P hydrolysis, which are not obvious from the structure of PTP1B/peptide complex. Thus, Tyr46 and Asp48 recognize common features of peptide substrates and are important for peptide substrate binding and/or E-P formation. Arg47 acts as a determinant of substrate specificity and is responsible for the modest preference of PTP1B for acidic residues NH2-terminal to phosphotyrosine. Phe182 and the invariant Gln262 are not only important for substrate binding and/or E-P formation but also important for the E-P hydrolysis step.