Alveolar rhabdomyosarcomas are pediatric solid tumors with a hallmark cytogenetic abnormality: translocation of chromosomes 2 and 13 [t(2;13) (q35;q14)]. The genes on each chromosome involved in this translocation have been identified as the transcription factor-encoding genes PAX3 and FKHR. The NH2-terminal paired box and homeodomain DNA-binding domains of PAX3 are fused in frame to COOH-terminal regions of the chromosome 13-derived FKHR gene, a novel member of the forkhead DNA-binding domain family. To determine the role of the fusion protein in transcriptional regulation and oncogenesis, we identified the PAX3-FKHR fusion protein and characterized its function(s) as a transcription factor relative to wild-type PAX3. Antisera specific to PAX3 and FKHR were developed and used to examine PAX3 and PAX3-FKHR expression in tumor cell lines. Sequential immunoprecipitations with anti-PAX3 and anti-FKHR sera demonstrated expression of a 97-kDa PAX3-FKHR fusion protein in the t(2;13)-positive rhabdomyosarcoma Rh30 cell line and verified that a single polypeptide contains epitopes derived from each protein. The PAX3-FKHR protein was localized to the nucleus in Rh30 cells, as was wild-type PAX3, in t(2;13)-negative A673 cells. In gel shift assays using a canonical PAX binding site (e5 sequence), we found that DNA binding of PAX3-FKHR was significantly impaired relative to that of PAX3 despite the two proteins having identical PAX DNA-binding domains. However, the PAX3-FKHR fusion protein was a much more potent transcriptional activator than PAX3 as determined by transient cotransfection assays using e5-CAT reporter plasmids. The PAX3-FKHR protein may function as an oncogenic transcription factor by enhanced activation of normal PAX3 target genes.