ISG15 is an IFN-alpha/beta-induced, ubiquitin-like protein that is conjugated to a wide array of cellular proteins through the sequential action of three conjugation enzymes that are also induced by IFN-alpha/beta. Recent studies showed that ISG15 and/or its conjugates play an important role in protecting cells from infection by several viruses, including influenza A virus. However, the mechanism by which ISG15 modification exerts antiviral activity has not been established. Here we extend the repertoire of ISG15 targets to a viral protein by demonstrating that the NS1 protein of influenza A virus (NS1A protein), an essential, multifunctional protein, is ISG15 modified in virus-infected cells. We demonstrate that the major ISG15 acceptor site in the NS1A protein in infected cells is a critical lysine residue (K41) in the N-terminal RNA-binding domain (RBD). ISG15 modification of K41 disrupts the association of the NS1A RBD domain with importin-alpha, the protein that mediates nuclear import of the NS1A protein, whereas the RBD retains its double-stranded RNA-binding activity. Most significantly, we show that ISG15 modification of K41 inhibits influenza A virus replication and thus contributes to the antiviral action of IFN-beta. We also show that the NS1A protein directly and specifically binds to Herc5, the major E3 ligase for ISG15 conjugation in human cells. These results establish a "loss of function" mechanism for the antiviral activity of the IFN-induced ISG15 conjugation system, namely, that it inhibits viral replication by conjugating ISG15 to a specific viral protein, thereby inhibiting its function.