The development of the single cell layer skin or hypodermis of Caenorhabditis elegans is an excellent model for understanding cell fate specification and differentiation. Early in C. elegans embryogenesis, six rows of hypodermal cells adopt dorsal, lateral or ventral fates that go on to display distinct behaviors during larval life. Several transcription factors are known that function in specifying these major hypodermal cell fates, but our knowledge of the specification of these cell types is sparse, particularly in the case of the ventral hypodermal cells, which become Vulval Precursor Cells and form the vulval opening in response to extracellular signals. Previously, the gene pvl-4 was identified in a screen for mutants with defects in vulval development. We found by whole genome sequencing that pvl-4 is the Paired-box gene pax-3, which encodes the sole PAX-3 transcription factor homolog in C. elegans. pax-3 mutants show embryonic and larval lethality, and body morphology abnormalities indicative of hypodermal cell defects. We report that pax-3 is expressed in ventral P cells and their descendants during embryogenesis and early larval stages, and that in pax-3 reduction-of-function animals the ventral P cells undergo a cell fate transformation and express several markers of the lateral seam cell fate. Furthermore, forced expression of pax-3 in the lateral hypodermal cells causes them to lose expression of seam cell markers. We propose that pax-3 functions in the ventral hypodermal cells to prevent these cells from adopting the lateral seam cell fate. pax-3 represents the first gene required for specification solely of the ventral hypodermal fate in C. elegans providing insights into cell type diversification.