Dysregulation of the Hedgehog (Hh)-Gli signaling pathway is implicated in a variety of human cancers, including basal cell carcinoma (BCC), medulloblastoma (MB) and embryonal rhabdhomyosarcoma (eRMS), three principle tumors associated with human Gorlin syndrome. However, the cells of origin of these tumors, including eRMS, remain poorly understood. In this study, we explore the cell populations that give rise to Hh-related tumors by specifically activating Smoothened (Smo) in both Hh-producing and -responsive cell lineages in postnatal mice. Interestingly, we find that unlike BCC and MB, eRMS originates from the stem/progenitor populations that do not normally receive active Hh signaling. Furthermore, we find that the myogenic lineage in postnatal mice is largely Hh quiescent and that Pax7-expressing muscle satellite cells are not able to give rise to eRMS upon Smo or Gli1/2 overactivation in vivo, suggesting that Hh-induced skeletal muscle eRMS arises from Hh/Gli quiescent non-myogenic cells. In addition, using the Gli1 null allele and a Gli3 repressor allele, we reveal a specific genetic requirement for Gli proteins in Hh-induced eRMS formation and provide molecular evidence for the involvement of Sox4/11 in eRMS cell survival and differentiation.