diff --git a/changelog/1028.bugfix b/changelog/1028.bugfix
new file mode 100644
index 0000000..39bc7a9
--- /dev/null
+++ b/changelog/1028.bugfix
@@ -0,0 +1 @@
+Fix compatiblity issue between `looponfail` and editable installs.
diff --git a/src/xdist/looponfail.py b/src/xdist/looponfail.py
index 7ef24c1..370cb8b 100644
--- a/src/xdist/looponfail.py
+++ b/src/xdist/looponfail.py
@@ -160,7 +160,8 @@ def init_worker_session(channel, args, option_dict):
     newpaths = []
     for p in sys.path:
         if p:
-            if not os.path.isabs(p):
+            # Ignore path placeholders created for editable installs
+            if not os.path.isabs(p) and not p.endswith(".__path_hook__"):
                 p = os.path.abspath(p)
             newpaths.append(p)
     sys.path[:] = newpaths
diff --git a/testing/test_looponfail.py b/testing/test_looponfail.py
index 92d4384..65a89fb 100644
--- a/testing/test_looponfail.py
+++ b/testing/test_looponfail.py
@@ -1,3 +1,5 @@
+import pathlib
+import tempfile
 import unittest.mock
 from typing import List
 
@@ -191,6 +193,43 @@ class TestRemoteControl:
         control.loop_once()
         assert control.failures
 
+    def test_ignore_sys_path_hook_entry(
+        self, pytester: pytest.Pytester, monkeypatch: pytest.MonkeyPatch
+    ) -> None:
+        # Modifying sys.path as seen by the worker process is a bit tricky,
+        # because any changes made in the current process do not carry over.
+        # However, we can leverage the `sitecustomize` behavior to run arbitrary
+        # code when the subprocess interpreter is starting up. We just need to
+        # install our module in the search path, which we can accomplish by
+        # adding a temporary directory to PYTHONPATH.
+        tmpdir = tempfile.TemporaryDirectory()
+        with open(pathlib.Path(tmpdir.name) / "sitecustomize.py", "w") as custom:
+            print(
+                textwrap.dedent(
+                    """
+                    import sys
+                    sys.path.append('dummy.__path_hook__')
+                    """
+                ),
+                file=custom,
+            )
+
+        monkeypatch.setenv("PYTHONPATH", tmpdir.name, prepend=":")
+
+        item = pytester.getitem(
+            textwrap.dedent(
+                """
+                def test_func():
+                    import sys
+                    assert "dummy.__path_hook__" in sys.path
+                """
+            )
+        )
+        control = RemoteControl(item.config)
+        control.setup()
+        topdir, failures = control.runsession()[:2]
+        assert not failures
+
 
 class TestLooponFailing:
     def test_looponfail_from_fail_to_ok(self, pytester: pytest.Pytester) -> None: