/Jeff Christensen/AP Microsoft founder and CEO Bill Gates

If U.S. District Thomas Penfield Jackson were to agree to such a dramatic solution, a mandated breakup of Bill Gates' Seattle-based empire would carry enormous implications for the way consumers buy and use software for their computers.

Justice Department lawyers laid out their proposal favoring to break Microsoft into three parts during a secret meeting last week in Washington with representatives of 19 states, people close to the case said. The states are also suing the company over alleged antitrust violations.

Those close to the discussions spoke on condition of anonymity, concerned they might anger U.S. Circuit Judge Richard Posner, the federal mediator in Chicago holding ongoing settlement talks. But they indicated little progress has been made so far in those discussions, as the sides remain far apart on important issues.

The government's endorsement of a breakup — considered the "death penalty" among possible remedies — could encourage Microsoft to seek a lesser sanction during settlement talks. But it could also stymie negotiations and encourage Microsoft to battle the case through America's courts for years.

The Justice Department, which last month disclosed that it had hired as its adviser a financial consulting firm, Greenhill & Co. LLC of New York, believes that lesser sanctions — such as prohibiting the company from abusing its influence or publishing its wholesale prices — would be inadequate to rein in Microsoft.

The Justice Department declined to publicly discuss its plans.

It wasn't immediately clear exactly how the government envisions the restructuring of one of America's most successful companies, with $19.7 billion in sales last year alone. But one source said lawyers will not propose dividing Microsoft into one company to sell its dominant Windows operating system, another to sell its software applications and a third to sell its Internet content.

Another breakup option that had been under consideration was dividing Microsoft into smaller duplicate companies, dubbed "Baby Bills" after the company's famous billionaire chairman, that would be set against each other to compete.

The 19 state attorneys general, who hired their own advisers separately from Justice, are deciding whether to endorse Justice's breakup proposal but are leaning in favor of it, sources said. At least one state has cautioned that a breakup could be unduly disruptive to consumers, who rely on Windows as a de facto standard to run their software applications and their PCs.

Critics warn that competing versions of Windows could lead to software that doesn't run on some versions or some computers.

Breaking up Microsoft into smaller companies would be "stupid, because it just creates confusion in the marketplace," said Michael Cusumano, a professor at the Massachusetts Institute of Technology who has written about Microsoft's battle with the former Netscape Communications Corp. "The breakup sounds like a mess to me."

The government expects to formally present the breakup plan next week when it meets privately again in Chicago with Posner, the mediator.

Jackson, the trial judge, urged government lawyers bluntly during a private meeting in November to agree among themselves on sanctions before they bring any formal recommendation for him to consider.

Microsoft spokesman Jim Cullinan said Wednesday that "the notion of breaking up Microsoft is an extreme and radical proposal not justified by what has been presented in this case."

USA Today, citing unnamed sources, reported Wednesday that the government favored breaking Microsoft into two parts, not three, and that one company would sell Windows and the other would sell its software applications.

Jackson handed down a blistering ruling Nov. 5 that Microsoft is a monopoly that stifled competition and hurt consumers, agreeing with nearly all the government's allegations against the company.

The tenor of that ruling raised the possibility of a serious, eventual judgment against Microsoft. Lawyers and analysts said then that it indicated Jackson might even be willing to consider a remedy as dramatic as a breakup. The next round of courtroom arguments is next month.

The disclosure that Justice favors a breakup comes on the heels of a high-tech analyst firm, International Data Corp., concluding that splitting Microsoft into separate companies "would be best" for the nation's high-tech industry.

It called a voluntary breakup "a brilliant leapfrog maneuver that would time-warp the company into the next millennium with renewed purpose and a shining political patina."

But the firm, in a report sent to its software clients and obtained by The Associated Press, also predicted that, "Microsoft will choose to settle the case before it would allow itself to be broken up."

Microsoft lost more than $18 billion in stock market value on Wednesday. The company's shares were down $3.56 1/4, or 3.3 percent, at $105.81 1/4 when the Nasdaq Stock Market closed at 4 p.m. EST.