I don't know what software you are using, or how you have it set up in your PC, but as a general rule it's usually best to send the digital signal out with no volume reduction, or any other manipulation.  The idea is to allow the DAC to work with an unmodified digital signal as provided from your music file.  Do the volume control farther down stream, preferably the preamp.
 

I agree.

This is more what I meant to ask, should have worded it differently.

Is my PC volume reducing the digital signal FROM 100% or amplifying it TO 100%?

For what it's worth, I use Foobar2000 as a music player, and select the output sample rate/bit depth to match the file from the audio control panel.

Software volume control could be considered reducing from 100%, because the music file can be considered at full volume.  (I'm sure this is an over simplification)

I'm also a user of Foobar2000.  Would you care to say what output device you are using in Foobar2000.  It's listed in Foobar2000's >Preferences >Output >Device field.  Along with your PC's OS, this information would help indicate how close you are to the goal of bit perfect output.

For example- When I play through my netbook's's built in speakers, I select the PC's audio chip- Realtek HD Audio Output in Foobar's device list. This signal is run through the Windows XP OS and is altered in ways I can only guess at.

My previous m902 DAC, through USB, defaulted to Windows driver, so I installed ASIO4ALL and selected ASIO driver as device to bypass XP.

When I connect to my current Dac through USB, I select Grace m903 which uses a third party driver, thesycon, that bypasses any Windows XP signal alteration. I don't know if I could even lower the volume in windows, never tried it. I know I can lower the volume in Foobar, which I found out when I did it by mistake, but I make sure to have every software volume control I can find in Windows, and Foobar set to maximum, and then just control the volume on the DAC/Preamp.

I'm not sure how this relates when you are using a coaxial output.  I'm curious whether the same steps are needed with coax to keep the OS from reprocessing the signal.  Maybe depends somewhat on whether an add in soundcard, or an on board chip is used.

My output device is "Realtek Digital Output (Realtek High Definition Audio)"

It is a built in audio chip and the SPDIF jack is part of the motherboard and therefor, I would guess, low level hardware.  I'm using Win7 Ultimate x64.  

That's the same setup I have on my desktop PC which I only use for casual listening through PC speakers.

I have read a report, and it seems with the Realtek and windows 7 you could benefit from a bitperfect output by using the Foobar wasapi plugin.   http://www.foobar2000.org/components/view/foo_out_wasapi

A little Info on wasapi if you want to get started, http://wiki.hydrogenaudio.org/index.php?title=Foobar2000:Components_0.9/foo_out_wasapi

And here are detailed setup instructions from Cambridge Audio using windows 7, and Foobar2000. It's for a USB connection, so there are bound to be some differences, but should be some help.  I think maybe what you would look for in your case is wasapi s/pdif listed in foobar's device list.  http://www.cambridgeaudio.com/assets/documents/Windows_7_WASAPI_setup.pdf

Or you could use USB connection :)

Thanks for this!  Setup was virtually identical for S/PDIF, and it worked right away.

Some very interesting effects.  The first album I played I was able to notice a HUGE difference right away, but the next album I had to listent to nearly the whole thing to determine any change, and it seems like some don't change at all.  Any reason why this might be?  They are all lossless flac files...

I don't suppose there is any way to get iTunes to do this?  For my lower quality music?

Glad it's working.  Can't be much help on your last question, I only use iTunes when I have to, and I don't have to very often. My wife did choose an iPhone, haha

sent from my Galaxy Nexus