The t(2;13) chromosomal translocation is found in the majority of human alveolar rhabdomyosarcomas (RMS). The resulting PAX3-FKHR fusion protein contains PAX3 DNA-binding domains fused to the potent transactivation domain of FKHR, suggesting that PAX3-FKHR functions to deregulate PAX3-specific target genes and signaling pathways. We previously developed transgenic mice expressing PAX3-FKHR under the control of mouse Pax3 regulatory sequences to test this hypothesis. We reported that PAX3-FKHR interferes with normal Pax3 developmental functions, with mice exhibiting neural tube and neural crest abnormalities that mimic those found in Pax3-deficient Splotch mice. Here we expanded those studies to show that developmental expression of PAX3-FKHR results in aberrant myogenesis in the developing somites and neural tube, leading to ectopic skeletal muscle formation in the mature spinal cord. Gene expression profiling indicated that PAX3-FKHR expression in the developing neural tube induces a myogenic pattern of gene expression at the expense of the normal neurogenic program. Somite defects in PAX3-FKHR transgenic animals resulted in skeletal malformations that included rib fusions and mis-attachments. As opposed to the neural tube defects, the severity of the rib phenotype was rescued by reducing Pax3 levels through mating with Splotch mice. Embryos from the transgenic line expressing the highest levels of PAX3-FKHR had severe neural tube defects, including exencephaly, and almost half of the embryos died between gestational ages E13.5-E15.5. Nearly all of the embryos that survived to term died after birth due to severe spina bifida, rather than the absence of a muscular diaphragm. These studies reveal a prominent role for PAX3-FKHR in disrupting Pax3 functions and in deregulating skeletal muscle development, suggesting that this fusion protein plays a critical role in the pathogenesis of alveolar RMS by influencing the commitment and differentiation of the myogenic cell lineage.