Kai Jiang, Yajuan Liu, Jie Zhang, and Jianhang Jia Smoothened (Smo), a GPCR family protein, plays a critical role in the reception and transduction of Hedgehog (Hh) signal. Smo is phosphorylated and activated on the cell surface; however, it is unknown whether Smo can be intracellularly activated. Here, we demonstrate that inactivation of the ESCRT-III causes dramatic accumulation of Smo in the ESCRT-III/MVB compartment, and subsequent activation of Hh signaling. In contrast, inactivation of ESCRTs 0–II induces mild Smo accumulation in the ESCRT-III/MVB compartment. We provide evidence that Kurtz (Krz), the Drosophila β-arrestin2, acts in parallel with the ESCRTs 0-II pathway to sort Smo to the multivesicular bodies and lysosome-mediated degradation. Additionally, upon inactivation of ESCRT-III, all active and inactive forms of Smo are accumulated. Endogenous Smo accumulated upon ESCRT-III inactivation is highly activated, which is induced by phosphorylation but not sumoylation. Taken together, our findings demonstrate a model for intracellular activation of Smo, raising the possibility for tissue overgrowth caused by an excessive amount, rather than mutation of Smo.