[show abstract][hide abstract] ABSTRACT: We show here that the Drosophila MADF/BESS domain transcription factor Dip3, which is expressed in differentiating photoreceptors, regulates neuronal differentiation in the compound eye. Loss of Dip3 activity in photoreceptors leads to an extra photoreceptor in many ommatidia, while ectopic expression of Dip3 in non-neuronal cells results in photoreceptor loss. These findings are consistent with the idea that Dip3 is required non-cell autonomously to block extra photoreceptor formation. Dip3 may mediate the spatially restricted potentiation of Notch (N) signaling since the Dip3 misexpression phenotype is suppressed by reducing N signaling and misexpression of Dip3 leads to ectopic activity of a N-responsive enhancer. Analysis of mosaic ommatidia suggests that no specific photoreceptor must be mutant to generate the mutant phenotype. Remarkably, however, mosaic pupal ommatidia with three or fewer Dip3(+) photoreceptors always differentiate an extra photoreceptor, while those with four or more Dip3(+) photoreceptors never differentiate an extra photoreceptor. These findings are consistent with the notion that Dip3 in photoreceptors activates a heretofore unsuspected diffusible ligand that may work in conjunction with the N pathway to prevent a subpopulation of undifferentiated cells from choosing a neuronal fate.