The work will now be carried out by a new department called the Defense Counterintelligence and Human Intelligence Center, overseen by the Pentagon's Defense Intelligence Agency.
Protesters' data 'kept'
Talon, an acronym for Threat and Local Observation Notice, was created by Donald Rumsfeld, the former US defence secretary, in February 2002 in response to the September 11 attacks.
In December 2005 it was disclosed that the system included data on anti-military protests and other peaceful demonstrations including the names of people who attended peace rallies.
A 2006 Pentagon review found as many as 260 reports in the database were wrongly collected or held.
It also said there were about 13,000 entries in the database, of which less than two per cent were wrongly added or not purged later when they were determined not to involve real threats.
Talon was ended last year as a result of the controversy but the Pentagon decided to reorganise the entire department after reviewing intelligence operations, officials said.
A senior US defence official told Reuters that Robert Gates, the current defence secretary, approved the change after the review found the office's functions could be performed more effectively by another agency.