The first step in the catalytic mechanism of a protein tyrosine phosphatase, the transfer of a phosphate group from the phosphotyrosine substrate to a cysteine side chain of the protein to form a phosphoenzyme intermediate, has been studied by combining density functional calculations of an active-site cluster with continuum electrostatic descriptions of the solvent and the remainder of the protein. This approach provides the high level of quantum chemical methodology needed to adequately model phosphotransfer reactions with a reasonable description of the environment around the active site. Energy barriers and geometries along a reaction pathway are calculated. In the literature, mechanisms assuming both a monoanionic and a dianionic substrate have been proposed; this disagreement is addressed by performing calculations for both possibilities. For the dianionic substrate, a dissociative reaction pathway with early proton transfer to the leaving group and a 9 kcal/mol energy barrier is predicted (the experimental estimate is ca. 14 kcal/mol), while for the monoanionic substrate, an associative pathway with late proton transfer and a 22 kcal/mol energy barrier is predicted. These results, together with a review of experimental evidence, support the dianionic-substrate/dissociative-pathway alternative. The relationship between a dianionic or monoanionic substrate and a dissociative or associative pathway, respectively, can be understood in terms of classical organic chemical reaction pathways.