To make your app close properly, follow this general advice.

• Make all child forms members of the MainForm class (in this case the main window is Form 1)
• Whenever you Show() a child form, pass the this pointer of the parent window. This way the child window will always be on top and you won’t have to “BringToFront”.
• Make sure to override the FormClosing event in any child form. If user is closing it, cancel the Close and Hide it instead. This way the native window handle doesn’t get disposed before you want it to.

Another change is that I added a handler that tracks the visibility of form 2 and makes form 1 visibility “the opposite of that”.

Some functionality has been shortened for clarity, but the aim here is to show the proper management of window Handle so that your app closes properly.

Form 1 (Main Window)

public partial class Form1 : Form
{
    internal static string UserPath => Path.Combine(AppDomain.CurrentDomain.BaseDirectory, "Users.txt");

    /// <summary>
    /// The main window of the app.
    /// </summary>
    public Form1()
    {
        InitializeComponent();
        txtCreatePass.PasswordChar = '*';
#if false
        // A way to reset the file for debugging.
        if(File.Exists(UserPath)) File.Delete(UserPath);
#endif
        form2.VisibleChanged += (sender, e) =>
        {
            // Hide this for when form2 shows.
            if (form2.Visible) Hide();
            else
            {
                if (form2.DialogResult == DialogResult.Yes)
                {
                    // Exit the app if form 2 has requested it.
                    Close();
                }
                else
                {
                    // Show this for when form2 hides.
                    Show();
                }
            }
        };
    }
    // This should be a class member.
    Form2 form2 = new Form2();

    private void button1_Click(object sender, EventArgs e)
    {
        if (string.IsNullOrWhiteSpace(txtCreateUser.Text) || string.IsNullOrWhiteSpace(txtCreatePass.Text))
        {
            // SKIP THIS CHECK by simply making [Button 1] invisible until the form is valid.
            MessageBox.Show("Please fill out form completely");
        }
        else
        {
            MessageBox.Show("Account Created");
            // Shortened for clarity
            // MAKE SURE YOU NEVER 'REALLY' SAVE A PASSWORD IN THIS MANNER. REALLY. NEVER.
            File.AppendAllLines(UserPath, [$"{txtCreateUser.Text}t{txtCreatePass.Text}"]);
            // Add 'this'
            form2.Show(this);
        }
    }

    private void button2_Click(object sender, EventArgs e)
    {
        Hide();
        // Add 'this'
        form2.Show(this);
        // No need to do this form2.BringToFront();
    }

    // Don't do this
    //private void Form1_FormClosed(object sender, FormClosedEventArgs e)
    //{
    //    System.Windows.Forms.Application.Exit();
    //}
}

Form 2

public partial class Form2 : Form
{
    public Form2()
    {
        InitializeComponent();
        txtPass.PasswordChar = '*';
    }

    private void button1_Click(object sender, EventArgs e)
    {
        // Shortened for clarity
        if(File.Exists(Form1.UserPath))
        {
            foreach (var line in File.ReadAllLines(Form1.UserPath))
            {
                var lineArray = line.Split("t");
                if (txtUser.Text == lineArray[0] && txtPass.Text == lineArray[1])
                {
                    MessageBox.Show("WORKS");
                    return;
                }
            }
            MessageBox.Show("DOES NOT WORK - did you ever assign txtName.Text and txtPass.Text?");
            return;
        }
        MessageBox.Show("FILE DOES NOT EXIST");
    }

    private void button2_Click(object sender, EventArgs e)
    {
        Hide();
    }

    // DO Add this to prevent this window from disposing when user clicks [X]
    protected override void OnFormClosing(FormClosingEventArgs e)
    {
        if (!Modal && e.CloseReason == CloseReason.UserClosing)
        {
            DialogResult = MessageBox.Show(
                this,
                "Exit app?", 
                "Form 2 wants to close app", 
                buttons: MessageBoxButtons.YesNo);
            e.Cancel = true;
            Hide();
        }
        base.OnFormClosing(e);
    }

    // Don't do this
    //private void Form2_FormClosed(object sender, FormClosedEventArgs e)
    //{
    //    System.Windows.Forms.Application.Exit();
    //}
}

Another thing you can put in the Form 1 constructor, that shouldn’t be necessary but might provide some cheap insurance, is an explicit dispose when the main form does.

// Shouldn't be necessary, but it's cheap insurance.
public Form1()
{
    Disposed += (sender, e) =>
    {
        form2.Dispose();
    };
}

As mentioned, everytime you want to show a form, you create object representing it with new keyword. So you have many abandoned objects that may hold resources and keep your app alive.

You are showing just 2 forms and you just need one object for each form to display and hide them. The trick is that each form has to hold reference to the other form to manage it. Here’s my skeleton code which works as expected:

// Form1.cs
public partial class Form1 : Form
{
    private readonly Form2 _form2;

    public Form1()
    {
        InitializeComponent();
        FormClosing += (s, e) => Application.Exit();
        _form2 = new Form2(this);
    }

    private void button1_Click(object sender, EventArgs e)
    {
        Hide();
        _form2.Show();
    }
}

// Form2.cs
public partial class Form2 : Form
{
    private readonly Form1 _form1;

    public Form2(Form1 form1)
    {
        InitializeComponent();
        FormClosing += (s, e) => Application.Exit();
        _form1 = form1;
    }

    private void button1_Click(object sender, EventArgs e)
    {
        Hide();
        _form1.Show();
    }
}