The study examined the impact of the phonemic and lexical distance between Modern Standard Arabic (MSA) and a spoken Arabic vernacular (SAV) on phonological analysis among kindergarten (N=24) and first grade (N=42) native Arabic-speaking children. We tested the effect of the lexical status of the word (SAV, MSA, and pseudoword), as well as the linguistic affiliation of the target phoneme (SAV vs. MSA), on initial and final phoneme isolation. Results showed that, when words were composed of SAV phonemes only, the lexical status of the word did not affect phoneme isolation. However, when MSA and pseudowords encoded both SAV and MSA phonemes, kindergarteners found MSA words significantly more difficult to analyze. Comparing children's ability to isolate SAV versus MSA phonemes revealed that all children found MSA phonemes significantly more difficult to isolate. Kindergarteners found MSA phonemes that were embedded within MSA words even more difficult to isolate. Results underscore the role of the lexical status of the stimulus word, as well as the linguistic affiliation of the target phoneme in phonological analysis in a diglossic context.