ABSTRACT Protein tyrosine phosphatase 1B (PTP1B, also known as PTPN1) is an established regulator of cell-matrix adhesion and motility. However, the nature of substrate targets at adhesion sites remains to be validated. Here, we used bimolecular fluorescence complementation assays, in combination with a substrate trapping mutant of PTP1B, to directly examine whether relevant phosphotyrosines on paxillin and focal adhesion kinase (FAK, also known as PTK2) are substrates of the phosphatase in the context of cell-matrix adhesion sites. We found that the formation of catalytic complexes at cell-matrix adhesions requires intact tyrosine residues Y31 and Y118 on paxillin, and the localization of FAK at adhesion sites. Additionally, we found that PTP1B specifically targets Y925 on the focal adhesion targeting (FAT) domain of FAK at adhesion sites. Electrostatic analysis indicated that dephosphorylation of this residue promotes the closed conformation of the FAT 4-helix bundle and its interaction with paxillin at adhesion sites.