Drexel Settles $5.3-Billion Tax Case With IRS : Wall Street: The agreement, which must be approved by the Treasury and Justice departments, allows the former brokerage to avert a trial.

The Internal Revenue Service tentatively agreed to settle its $5.3-billion tax claim against Drexel Burnham Lambert, seemingly clearing the way for the former brokerage to close its bankruptcy case.

Sources said the agreement with the IRS came Wednesday, averting a trial on the tax claim that was scheduled to begin today. Drexel previously had reached an accord with its thousands of creditors on dividing up the firm’s remaining $2.6 billion in assets. But the mammoth IRS claim had threatened to wreck the deal.

The amount Drexel agreed to pay the IRS wasn’t disclosed. U.S. District Judge Milton Pollack in New York, who is supervising the bankruptcy case, instructed both sides not to talk about the settlement until it has been formally approved by the Justice Department and the Treasury Department.

Drexel’s creditors had agreed among themselves to scuttle their pact on ending the bankruptcy case if the final IRS tax bill took up too much of the firm’s assets. One source close to the case said the amount the IRS agreed to is small enough to allow the bankruptcy pact to survive.

Pollack told Reuters news service that the trial had been postponed because “when there is a tentative settlement, everything is put on hold.” He also said that now “it’s a question of approval, not of settlement.”

Part of the tax claim stemmed from the IRS’ disallowance of about $1.4 billion in deductions for what the IRS alleges was excessive compensation paid to Michael Milken, the firm’s former junk bond chief who currently is serving a 10-year prison sentence on securities-related charges. The IRS asserted that most of the payments really were dividends paid to a de facto controlling owner of the firm. Dividends, unlike salary payments, aren’t tax deductible. The IRS, for example, disallowed Drexel’s deduction of all but $50 million of the $550 million the firm paid to Milken in 1987.

The trial, which would have taken place before U.S. Bankruptcy Judge Francis C. Conrad in New York, was to have included testimony on how Milken’s compensation was determined.

Among other charges, the IRS also had alleged that Drexel didn’t properly substantiate about $2 billion in trading losses it claimed, and it disallowed about $270 million in tax losses the firm had bought from certain native Alaskan economic development corporations. Tax law had allowed the native Alaskan companies to sell tax losses to other U.S. corporations, which could then use the losses to lower their own tax bills.

In earlier court hearings, however, Judge Pollack, who is in ultimate charge of the bankruptcy case, had indicated that he believed the $5.3 billion in IRS tax claims were excessive.

Drexel’s pioneering use of junk bonds in the 1980s helped it grow into one of the leading Wall Street brokerages and investment banks. But after the firm pleaded guilty to six felony counts it lapsed into bankruptcy proceedings in February, 1990. Under the accord with creditors, a small firm, temporarily named Newco, would remain in business after the Chapter 11 bankruptcy case is resolved.