Can anyone explain why my HTPC is not able to output dolby digital directly to my AV receiver? I only get 2 channel, which is then up-converted by the receiver... Is this a hardware or software issue?

I have an Asus M2n-e motherboard with Coax (S/PDIF) out which runs the audio signal to my Onkyo SR-706 receiver. The motherboard has the current SoundMax HD audio drivers, yet playing a dolby DVD only outputs 2 channel.
I'm running 32-bit Vista, and play DVDs via windows media center.
I've gone under the control panel, and see nothing about surround sound options. I don't believe I need a dedicated sound card to deliver the native digital signal to my receiver, correct? Or an HDMI (audio-enabled) video card?

hopefully, that's all the relevant info...
Any advice would be appreciated!

Unfortunately, the only practical way to get digital multi-channel audio out of a PC in all cases is to use a soundcard capable of encoding into some lossy format such as Dolby Digital Live. For playing DVDs however, most player software should support passthrough, which just outputs the audio without decoding it first, so you get the original multichannel stream straight to your receiver.

In the notification area of the taskbar on the bottom right, there should be an icon for your HD sound controller. Mine is realtek, but your soundmax should be similar. Double clicking on this should allow you to change between default outputs and manage your speaker config.

Also, in media center there is an option to setup speakers, make sure all of them are outputting sound in this.

My guess is that Windows Media Center in and of itself does not support 5.1 sound. I say this because all commercial 3rd party software DVD players only support 5.1 if you pay for something above their base version. I'd think the simplest solution for you would be to install the appropriate ffdshow filter. I'd imagine the AC-3 one is what you want.

If you are playing an AC3 encoded source (DD or DTS), then your soundcard just has to be capable of (most are) and configured for "SPDIF Passthrough". There is usually an option for this in the soundcard driver utility, but the playback software must be configured for it as well.

See if you can get it to work with WMP first, then try VMC. VMC has it's own setup. Failing that, you can use ffdshow that jessekopelman suggested, but it's a bit cumbersome. AC3Filter is also free and is a little bit easier to navigate, along with there being plenty of setup guides for it.

VMC supports whatever playback the drivers are capable of, it doesn't know the difference.

Actually AC3Filter was what I was talking about. I got it bundled with other DirectShow filters and I just assumed it came with ffdshow. I really should have written DirectShow in my earlier post, not ffdshow . . .

I have the same problem in Win7's media center. When playing DVDs in just the regular Media Player, it correctly switches audio stream output when I choose 5.1 in the DVD's audio menu and my receiver sees the AC3 stream, but in the Media Center (which seems almost identical to Vista's) it just never makes the switch (though it seems to try, as the receiver does lose the previous LPCM stream for a second when I try to get it to switch). It works without flaw in the regular standalone media player, so it seems the issue is with the Media Center (or possibly MC not liking the SoundMAX integrated audio). FWIW, I did submit feedback to the team that supposedly is working on ironing out the bugs people report from the beta.

Actually, VMC has separate audio/video configurations from the standard windows config. Make sure your media center config is set to output 5.1 as well.

^ This is true. I personally despise the "setup" in VMC and 7MC. One of the many reasons is that it doesn't allow me to select anything other than 2ch when using digital coax, as though it doesn't even recognize that this is a valid way of outputting a compressed 5.1 stream. The impression I got is that the entire MC is an afterthought when you consider how much it dumbs down and oversimplifies a Home Theatre setup.... that or it just tells you to adjust your TV rather than providing the option to make the adjustments in software (whether for color, contrast, over/underscan settings, etc)

That's because those settings are done at the driver level (sometimes at the renderer level), not in MC. There would need to be a driver package and API that would have a MCML app written for it to be usable. And every OEM does it's drivers differently, so in the end, it's not something for MS to fix.

So far no luck with software solutions.
Can anyone recommend a decent sound card that will pass optical or coax signal for 5.1 movies to my a/v receiver? (and inexpensive)
Maybe the "Creative Sound Blaster X-Fi XtremeGamer"??

i also game occasionally... but the audio must still pass on the same digital audio output line to the receiver.

thanks for all the input... i have NO experience with add-on sound cards, mostly because I didn't see why they were necessary before!

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Well I thought all soundcards would support passthrough, but I did a quick google and it looks like it is a known driver problem, with at least one possible solution (I only glanced quickly at it so I don't know if it's likely to work for you).

But if you want multichannel digital output from games, then you have to do what I mentioned above and get a soundcard capable of real-time DDL (or equivalent) encoding (a stupid solution, but the only reasonable one at the moment).

If all you want is SPDIF passthrough, there are cheaper options.

But if you want to go all out, Auzentech has more expensive options with full Dolby Digital and DTS encoding.