The Federal government and the 19 states suing Microsoft, on antitrust grounds, believe a break-up of the software giant is the most suitable punishment, sources close to the case said.

A break-up into three smaller entities heads the list of the potential remedies drawn up by the US Department of Justice(DOJ), sources added.

One legal source, who requested anonymity, said: "Splitting up Microsoft maybe hasn't been decided on, but, [the government is] thinking about it hard and [wants] to see how it will go over."

Last week, the DOJ denied a USA Today report that it was eyeing a break-up of Microsoft into two companies. That report was "inaccurate in several important respects", DOJ spokeswoman Gina Talamona said.

However, the source close to the case said that the DOJ's denial did not rule out breaking up Microsoft, and that a different scenario - breaking Microsoft into three separate companies, not two - is what the government has in mind.

Once considered the most drastic punishment, many observers are now looking at a break-up of Microsoft in a different light.

"By creating separate 'baby Bills', a not inconsiderable force within Microsoft is unleashed to ride the new wave of Internet and potentially thin-client architectures," stated a recent International Data Corp report.

However, Microsoft officials remain publicly vociferous in their opposition to such a plan.

"It would be absolutely reckless and irresponsible for anyone to try to break up this company," Microsoft President and CEO Steve Ballmer said. "It would be unprecedented, and I think it would be the single greatest disservice that anybody could do to consumers."

Microsoft is accused of using a monopoly position, in the PC-operating systems market, to quash competition and move into other markets. Microsoft representatives vehemently deny the accusation, and say that competition is thriving.

US District Judge Thomas Penfield Jackson declared Microsoft a monopoly in November. He has invited both sides to issue briefs and present oral arguments on how the law should be applied in the case, before he comes to a final verdict.