Linear TAR RNA has previously been used as a decoy to inhibit HIV-1 transcription in vitro and HIV-1 replication in vivo, A 48 nucleotide circular RNA containing the stem, bulge and loop of the HIV-1 TAR element was synthesized using the self-splicing activity of a group I permuted intron-exon and was tested for its ability to function as a TAR decoy in vitro. This small circular TAR molecule was exceptionally stable in HeLa nuclear extracts, whereas a similar linear TAR molecule was rapidly degraded. The TAR circle bound specifically to Tfr38, a peptide containing the TAR-binding region of Tat. The ability of Tat to trans-activate transcription from the HIV-1 promoter in vitro was efficiently inhibited by circular TAR RNA but not by TAR circles that contained either bulge or loop mutations. TAR circles did not inhibit transactivation exclusively by binding to Tat since this inhibition was not reversed by adding excess Tat to the transcription reaction. Together, these data suggest that TAR circles act as decoys that inhibit transactivation by binding to Tat and at least one cellular factor. These data also demonstrate the utility of small circular RNA molecules as tools for biochemical studies.