Despite its strong antitumor activity, paclitaxel (Taxol) has limited clinical applications due to its low aqueous solubility and hypersensitivity caused by Cremophor EL and ethanol which is the vehicle used in the current commercial product. In an attempt to develop a pharmaceutically acceptable formulation that could replace Taxol, a paclitaxel incorporated liposome has been constructed to improve solubility and physicochemical stability. The effect of various components of the liposome, including cholesterol and lipid, on the solubility and entrapment efficiency (EE) of paclitaxel was systematically investigated. The results showed that 5% (v/v) of polyethylene glycol 400 in the hydration medium of liposome significantly increased the solubility (up to 3.39 mg/mL) as well as the EE and the paclitaxel content in the liposome formulation composed of 10% (w/v) of S(100)PC with cholesterol (cholesterol-to-lipid molar ratio = 10:90). When sucrose (sugar-to-lipid molar ratio = 2.3) was added as a lyoprotectant during the freeze-drying of the liposome, physicochemical stability of liposome was significantly improved. Moreover, the cytotoxicity of the final liposome formulation against MDA-MB-231 human breast cancer cell line was not significantly different from that of Taxol. The enhanced aqueous solubility as well as the physicochemical stability of paclitaxel in the liposome formulation developed in this study could be a safer and effective alternative to the Cremophor EL and ethanol formulation.