Insulin resistance is a major factor in the pathogenesis of type 2 diabetes and may be related to alterations in fat metabolism. Fatless mice have been created using dominant-negative protein (A-ZIP/F-1) targeted gene expression in the adipocyte and shown to develop diabetes. To understand the mechanism responsible for the insulin resistance in these mice, we conducted hyperinsulinemic-euglycemic clamps in awake fatless and wild type littermates before the development of diabetes and examined insulin action and signaling in muscle and liver. We found the fatless mice to be severely insulin-resistant, which could be attributed to defects in insulin action in muscle and liver. Both of these abnormalities were associated with defects in insulin activation of insulin receptor substrate-1 and -2-associated phosphatidylinositol 3-kinase activity and a 2-fold increase in muscle and liver triglyceride content. We also show that upon transplantation of fat tissue into these mice, triglyceride content in muscle and liver returned to normal as does insulin signaling and action. In conclusion, these results suggest that the development of insulin resistance in type 2 diabetes may be due to alterations in the partitioning of fat between the adipocyte and muscle/liver leading to accumulation of triglyceride in the latter tissues with subsequent impairment of insulin signaling and action.