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New Zealand Cricket boss David White made the announcement in Auckland at a tense press conference.
Taylor was offered the test captaincy but declined it. He will not travel to South Africa but will be available for the home series with England.
Taylor was reportedly asked to step down before last month's two-test series in Sri Lanka but refused and was told the captaincy would be stripped upon the conclusion of the tour.
After Taylor, New Zealand's best batsman, scored a century to lead his side to a rare test victory on foreign soil, NZC gave him chance to remain in charge in the longest form of the game.
But, disillusioned at his treatment, Taylor has decided to step aside from cricket altogether, and will not join his teammates on the upcoming tour of South Africa.
White said Taylor would return to the side for the home series against England this summer, where his relationship with Hesson will be firmly under the spotlight.
White was adamant the decision to strip the captaincy from Taylor was Hesson's alone, and refuted reports there was an element of player power.
"[Hesson] had concerns, not about [Taylor's] captaincy, but he felt it would be better for Ross to focus on his game,'' he said.
"It was felt that the work load for a young captain was a lot.''
White, who has been overseas this week, said it was regrettable the saga had been played out through the media, and he also apologised for the absence of Hesson, whose travel plans were scuppered by a cancelled flight.
A captaincy change has been in the works since Hesson, a relatively unknown coach, took charge of the team in July. Hesson has a close relationship with McCullum after coaching him in Otago but he has repeatedly denied the possibility of Taylor being asked to relinquish his post.
But Hesson has recently wavered in his assertions over Taylor's future, culminating in the sensational request in Sri Lanka.
The Black Caps' squad for the tour of South Africa will be announced later this afternoon in Christchurch.