Abstract Faithful chromosome segregation during mitosis is tightly regulated by opposing activities of Aurora B kinase and protein phosphatase‐1 ( PP 1). PP 1 function at kinetochores has been linked to SDS 22, but the exact localization of SDS 22 and how it affects PP 1 are controversial. Here, we confirm that SDS 22 is required for PP 1 activity, but show that SDS 22 does not normally localize to kinetochores. Instead, SDS 22 is kept in solution by formation of a ternary complex with PP 1 and inhibitor‐3 (I3). Depletion of I3 does not affect the amount of PP 1 at kinetochores but causes quantitative association of SDS 22 with PP 1 on KNL 1 at the kinetochore. Such accumulation of SDS 22 at kinetochores interferes with PP 1 activity and inhibits Aurora B threonine‐232 dephosphorylation, which leads to increased Aurora B activity in metaphase and persistence in anaphase accompanied with segregation defects. We propose a model in which I3 regulates an SDS 22‐mediated PP 1 activation step in solution that precedes SDS 22 dissociation and transfer of PP 1 to kinetochores, and which is required for PP 1 to efficiently antagonize Aurora B.