In signaling involving the transforming growth factor-beta (TGF-beta) superfamily of proteins, ligand binding brings the constitutively active type II receptor kinase into close proximity to its substrate, the type I receptor kinase, which it then activates by phosphorylation. The type I receptor kinase in turn phosphorylates one of the Smad family of transcription factors, which translocates to the nucleus and regulates gene expression. Smads are recruited to the receptor complex by an anchor protein, SARA (Smad anchor for receptor activation). Although several protein kinases in this pathway were known, including the receptors themselves, the relevant phosphatases had not previously been identified. Here we report the isolation of a Drosophila melanogaster homolog of SARA (Sara) in a screen for proteins that bind the catalytic subunit of type 1 serine/threonine protein phosphatase (PP1c). We identified a PP1c-binding motif in Sara, disruption of which reduced the ability of Sara to bind PP1c. Expression of this non-PP1c-binding mutant resulted in hyperphosphorylation of the type I receptor and stimulated expression of a target of TGF-beta signaling. Reducing PP1c activity enhanced the increase in the basal level of expression of genes responsive to Dpp (Decapentaplegic) caused by ectopic expression of the type II receptor Punt. Together these data suggest that PP1c is targeted to Dpp receptor complexes by Sara, where it acts as a negative regulator of Dpp signaling by affecting the phosphorylation state of the type I receptor.