Paclitaxel is a famous chemotherapeutic agent, but its microbial production poses a long-standing challenge due to its poor product selectivity. Taxadiene-5α-hydroxylase (CYP725A4) plays a crucial role in the biosynthesis of paclitaxel, catalyzing the oxidation of taxadiene and iso-taxadiene. This process yields several products, including the byproducts 5(12)-oxa-3(11)-cyclotaxane (OCT) and 5(11)-oxa-3(11)-cyclotaxane (iso-OCT), as well as the target compound taxadien-5α-ol (T5OH). Despite extensive studies, the molecular mechanism of CYP725A4-catalyzed transformations is still elusive, which could impede our understanding of further engineering of the paclitaxel biosynthetic pathway. In this study, the crystal structure of CYP725A4 in complex with taxadiene is elucidated. Through comprehensive computational analyses, the catalytic mechanisms of CYP725A4 in the biosynthesis of natural paclitaxel are deciphered. Our calculations indicate that the oxidation of taxadiene affords a zwitterion intermediate, which can undergo two competing transformation routes. One involves the formation of epoxide, which further undergoes the water-mediated rearrangement to form the T5OH product. In the alternative pathway, protonation of the oxygen in the zwitterion intermediate facilitates subsequent hydride transfer and carbon–oxygen coupling, resulting in the side products OCT/iso-OCT. Contrary to taxadiene, hydroxylation at C5 of iso-taxadiene directly yields the target product T5OH. These crystallographic studies and computational analyses have yielded valuable insights into the catalytic mechanisms of CYP725A4 and laid the foundation for the further engineering of CYP725A4.