Under resting conditions, the p85 regulatory subunit of phosphatidylinositol 3-kinase (PI3K) serves to both stabilize and inactivate the p110 catalytic subunit. The inhibitory activity of p85 is relieved by occupancy of the NH(2)-terminal SH2 domain of p85 by phosphorylated tyrosine. Src family kinases phosphorylate tyrosine 688 in p85, a process that we have shown to be reversed by the activity of the p85-associated SH2 domain-containing phosphatase SHP1. We demonstrate that phosphorylation of the downstream PI3K target Akt is increased in cells lacking SHP1, implicating phosphorylation of p85 in the regulation of PI3K activity. Furthermore, the in vitro specific activity of PI3K associated with tyrosine- phosphorylated p85 is higher than that associated with nonphosphorylated p85. Expression of wild-type p85 inhibits PI3K enzyme activity as indicated by PI3K- dependent Akt phosphorylation. The inhibitory activity of p85 is accentuated by mutation of tyrosine 688 to alanine and reversed by mutation of tyrosine 688 to aspartic acid, changes that block and mimic tyrosine phosphorylation, respectively Strikingly, mutation of tyrosine 688 to aspartic acid completely reverses the inhibitory activity of p85 on cell viability and activation of the downstream targets Akt and NFkappaB, indicative of the physiological relevance of p85 phosphorylation. Tyrosine phosphorylation of Tyr(688) or mutation of tyrosine 688 to aspartic acid is sufficient to allow binding to the NH(2)-terminal SH2 domain of p85. Thus an intramolecular interaction between phosphorylated Tyr(688) and the NH(2)-terminal SH2 domain of p85 can relieve the inhibitory activity of p85 on p110. Taken together, the data indicate that phosphorylation of Tyr(688) in p85 leads to a novel mechanism of PI3K regulation.