The current study was undertaken to examine metabolic and body composition correlates of fatty liver in type 2 diabetes mellitus (DM). Eighty-three men and women with type 2 DM [mean body mass index (BMI): 34 ± 0.5 kg/m²] and without clinical or laboratory evidence of liver dysfunction had body composition assessments of fat mass (FM), visceral adipose tissue (VAT), liver and spleen computed tomography (CT) attenuation (ratio of liver to spleen), muscle CT attenuation, and thigh adiposity; these assessments were also performed in 12 lean and 15 obese nondiabetic volunteers. Insulin sensitivity was measured with a euglycemic insulin infusion (40 mU · m^–2 · min^–1) combined with systemic indirect calorimetry to assess glucose and lipid oxidation, and with infusions of [²H₂]glucose for assessment of endogenous glucose production. A majority of those with type 2 DM (63%) met CT criteria for fatty liver, compared with 20% of obese and none of the lean nondiabetic volunteers. Fatty liver was most strongly correlated with VAT (r = –0.57, P < 0.0001) and less strongly but significantly associated with BMI (r = –0.42, P < 0.001) and FM (r = –0.37, P < 0.001), but only weakly associated with subcutaneous adiposity (r = –0.29; P < 0.01). Fatty liver was also correlated with subfascial adiposity of skeletal muscle (r = –0.44; P < 0.01). Volunteers with type 2 DM and fatty liver were substantially more insulin resistant those with type 2 DM but without fatty liver (P < 0.001) and had higher levels of plasma free fatty acids (P < 0.01) and more severe dyslipidemia (P < 0.01), a pattern observed in both genders. Plasma levels of cytokines were increased in relation to fatty liver (r = –0.34; P < 0.01). In summary, fatty liver is relatively common in overweight and obese volunteers with type 2 DM and is an aspect of body composition related to severity of insulin resistance, dyslipidemia, and inflammatory markers.