Hd not recognized on dac...iTunes, pc, USB problem

I'll first address the format question:

No, you can't play FLAC on iTunes, and since you are using a PC, there is no free solution for converting FLAC to ALAC (m4a).

I used foobar2000 for quite some time before switching to JRMC15, and I think there are a few settings you need to check, both in foobar and Win7.

In Win7: Right click your volume icon in the tray and select "Playback Devices". You should see your W4S DAC as an available output device; select it and click properties. Once here, select the "Advanced" tab. Make sure that "Allow applications to take exclusive control of this device" is checked, as well as "Give exclusive mode applicaitons priority" Ensure that any "Signal Enhancements" are deselected. The shared mode bit depth and sampling frequency is not relevant when the device is being used in exclusive mode.

Once this is done, head into foobar. Find the section under settings that deals with "output" or "playback" settings. From the dropdown menu, you are able to select your device (W4S DAC) as well as the method of delivery to the outboard device. Your best options are WASAPI, ASIO, or Kernel Streaming (best choice, but requires a foobar2000 add-on). Ensure that one of these is selected and NOT Direct Sound or "DS".

You shouldn't have any more issues once you check and change the appropriate settings.

To more directly address one of your questions: If you're running Windows 7 audio output in shared mode, a sample rate conversion is certainly taking place. The audio is also being molested on its way out of the PC through digital EQ, volume leveling, peak clipping, THX mastering, surround processing, etc.; of which all are functions of the glorious Windows Kernel Mixer.