The hedgehog (Hh) pathway plays a critical role during development of embryos and cancer. Although the molecular basis by which protein kinase A (PKA) regulates the stability of hedgehog downstream transcription factor cubitus interruptus, the Drosophila homologue of vertebrate Gli molecules, is well documented, the mechanism by which PKA inhibits the functions of Gli molecules in vertebrates remains elusive. Here, we report that activation of PKA retains Gli1 in the cytoplasm. Conversely, inhibition of PKA activity promotes nuclear accumulation of Gli1. Mutation analysis identifies Thr374 as a major PKA site determining Gli1 protein localization. In the three-dimensional structure, Thr374 resides adjacent to the basic residue cluster of the nuclear localization signal (NLS). Phosphorylation of this Thr residue is predicted to alter the local charge and consequently the NLS function. Indeed, mutation of this residue to Asp (Gli1/T374D) results in more cytoplasmic Gli1 whereas a mutation to Lys (Gli1/T374K) leads to more nuclear Gli1. Disruption of the NLS causes Gli1/T374K to be more cytoplasmic. We find that the change of Gli1 localization is correlated with the change of its transcriptional activity. These data provide evidence to support a model that PKA regulates Gli1 localization and its transcriptional activity, in part, through modulating the NLS function.