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The economy contracted 0.16% compared to the previous year, the statistics agency said. Analyst were expecting slight growth.
The agency also cut its forecast for full year growth to 2.08% down from 3.03%.
Analysts said a slowdown in demand from China was one of the key factors.
"Given how weak Western markets remain, Beijing's loosening must start to lift mainland demand soon if Taiwan is to achieve a meaningful recovery in second half of 2012," said Donna Kwok from HSBC.
China, a major trade partner for Taiwan, especially for many of its high-tech goods, but has seen its own economy slow in recent months.
The government in Beijing has started taking steps to spur lending by cutting key interest rates and fast-tracking investment projects.
Taiwan's statistics office also cut its forecast for export growth to 0.07% down from 2.69%.
It cited a drop in exports of communications equipment, optronics and chemicals.
The bleak picture externally was compounded by a slowdown in domestic demand. However analysts said the worst could be over.
"The whole second quarter was weighed by Euro debt crisis, especially fears over the Greek election, and the whole world was in panic," said Aidan Wang from Yuanta Securities in Taipei.
"As the worst is over in Europe, Taiwan's third quarter gross domestic product should be able to return to positive, and then achieve over 3% in the fourth quarter," he said.
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