The cabinet immediately appointed Niwattumrong Boonsongpaisan as the caretaker premier, after the Constitutional Court unanimously ruled that Yingluck - Thailand's first woman Prime Minister - took part in the approval of the transfer of Thawil Pliensri from the position of National Security Council secretary general.
Yingluck's Pheu Thai party said the court's ruling was "a virtual coup against a democratic government" and a "conspiracy to remove the party from power".
Yingluck, 46, later appeared live on national television and insisted she did nothing wrong.
"We held true to the principles of honesty in running the country, and never acted corruptly, as we were accused," said Yingluck.
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Her nine cabinet ministers were also dismissed from office after the court found them complicit in the transfer, which the court said was done in an unusual haste in only four days and there was discrepancy in dates of related documents hence the process was irregular.
Jubilant anti-government demonstrators, who accuse Yingluck of acting as a proxy for her fugitive brother Thaksin and have been demanding her ouster for the last several months, blew whistles outside the court.
Yingluck has argued that she assigned her deputy to handle the issue so she did not take part in it.
"Transferring with a hidden agenda is not acceptable. The Constitutional Court has ruled unanimously that (Yingluck) has used her status as the prime minister to intervene for her own and others' benefits to (transfer) a government official," the court said in its verdict.
Buddhist-majority Thailand has been rocked by months of political violence that has left several people dead and hundreds wounded, including many anti-government protesters, in grenade attacks and shootings.
The Shinawatra family is one of the richest and most influential families in the country.