The decision by the Bush administration reverses the Clinton White House legal strategy against Microsoft.
The Department of Justice said that the decision was made in order to shorten the court proceedings and protect consumers.
Microsoft has been locked in a court battle with the US Government over anti-trust claims for the past three years.
The government's about-turn on demands for Microsoft to be broken into two companies - one for its Windows operating system and one for its other business and home software - is a victory for Microsoft.
But although the DoJ says it is no longer actively seeking a break-up, the court could still decide that this is a necessary solution to establish fair competition.
Browser controversy
In June this year the Appeal Court in the US accepted the original judgement, made in June 2000, that Microsoft's business practices had violated anti-trust laws.
But it threw out the remedy - a break-up into two separate companies - because it said media interviews by the previous judge could be seen as showing bias against the company.
District Court Judge Colleen Kollar-Kotelly was appointed by random selection earlier in August, and has ordered the two sides to report by 14 September on what issues remain outstanding.
The DoJ has also said that it had dropped further action on its complaint about the web browser being tied into Windows.
The fact that Microsoft unfairly tied its Internet Explorer web browser into the Windows operation system was the original complaint of the DoJ.
Speeding it up
The DoJ is trying to streamline the case with the goal of securing an effective remedy as quickly as possible.
During testimony in Congress the attorney-general, John Ashcroft, hedged when questioned by senators about the government's commitment to pursuing the lawsuit against Microsoft, saying that many issues needed reviewing.
Mr Ashcroft's department now says the government "believes it has established a basis for relief that would end Microsoft's unlawful conduct, prevent its recurrence and open the operating-systems market to competition."
Threat to Windows XP?
The DoJ will ask the court for a period of discovery to investigate developments in the industry since the trial concluded, and evaluate whether additional conduct-related provisions are necessary.
It will also try to force computer manufacturers to keep specific icons and programmes on the Windows desktop.
The proposed restrictions could have a large impact on the Microsoft's latest software, Windows XP, according to Howard University law professor Andy Gavil.
Windows XP is due to be launched in October.
"It's hard to square the interim remedy with Windows XP," Mr Gavil said.
"All of these little things really have to do with how XP is being prepared and marketed."
Mr Gavil said the Justice Department's action means the case could move more quickly and is more palatable to Bush appointees.
"Rather than fight the battle over breakup, get down to the brass tacks over how we can change their conduct now in a way that will preserve some competition in the marketplace," he said.
"It is probably more philosophically agreeable to the administration."
Opinion divided
The Department of Justice decision has divided opinion in the US.
"Microsoft put their bets on this horse and now it is time to collect their winnings ...
"This company performed an illegal operation but they will not be shut down.
"Nor, evidently, will they face any penalty likely to deter them from anticompetitive, predatory, and monopolistic behavior in the future."
But the American Conservative Union hailed the decision as a saving of taxpayer's money.
"The decade-long, multimillion-dollar, competitor-driven persecution of Microsoft is rapidly coming to a pertinent conclusion," said ACU chairman David Keene.
John Buckley, of Microsoft competitor AOL, said: "It's been clear for some time that the structural remedy to Microsoft's anticompetitive behavior would not be put into effect.
"What's clear today is that the Department of Justice is prepared to take a hard look at Windows XP and will pursue a quickly imposed remedy to open up competition on the desktop."