The Securities and Exchange Commission and the Internal Revenue Service are headed for a possible showdown over whether $15 million in illegal, insider stock trading profits surrendered by former investment banker Dennis B. Levine and his confederates should be used to pay federal taxes evaded by the dishonest traders -- or paid to stock market investors who claim to be Levine's victims.

Levine has pleaded guilty to both illegally trading on inside information and evading taxes on his illicit profits and has given $11.6 million in assets to a receiver appointed by the SEC.

But the IRS has filed claims against Levine for taxes, penalties and interest that totaled $10.7 million as of Dec. 31 and have grown even larger as the interest has mounted. An associate of Levine, Robert Wilkes, has paid the SEC $3.3 million, but has been hit with a $3.4 million tax bill. The process for deciding who is entitled to the funds is expected to move forward next week when the SEC files a distribution plan in federal court in New York.

"We are going to file the plan on Monday," said SEC enforcement division attorney Thomas C. Newkirk. "The plan will describe how we believe the disgorgement fund should be distributed among the competing claimants and will give competing claimants an opportunity to make their views on the plan known. ... There are tax claims from the IRS."

"The tax claims, if paid, would take up the entire fund," said another SEC attorney. "There would be nothing left for investors."

Levine and Wilkis have already asked the court-appointed receiver controlling the funds to use as much of the money as is needed to pay the IRS because otherwise they could remain liable for the taxes on the illegal trading profits.

Martin Flumenbaum, Levine's attorney, said yesterday he has a "letter agreement" with the SEC that stipulates that his client's taxes, interest and criminal fines will be paid out of the SEC fund. Flumenbaum said Levine turned over almost all of his assets to the government to settle the insider trading charges and would be unable to meet the multimillion dollar tax liabilities unless the SEC abides by the letter agreement.

"That is not what the letter says," the SEC's Newkirk said. "The letter says the tax claims are claims that can be made against the fund. Nowhere in the letter does it say we are going to pay the taxes or not pay the taxes."

Newkirk said Judge Richard Owen ruled that two other members of Levine's insider ring, David Brown and Ira Sokolow, could have their IRS claims settled using funds they paid the SEC to settle insider trading charges. However, he said the Brown and Sokolow cases were separate matters. Judge Owen will be presiding over the continuing dispute.

Amid the SEC's campaign to put a halt to the trading of stocks on the basis of confidential information about upcoming corporate takeovers, former commission chairman John Shad often said the agency was protecting investors. He said investors who sold their shares to violators, without the benefit of insider knowledge about upcoming takeover bids that the traders had, were cheated out of profits they would have received if they had held their shares until takeover bids were announced.

Typically, the announcement of a takeover bid causes sharp increases in a target company's stock price.

In keeping with the SEC's policy of investor protection, it is expected that the plan to be filed on Monday will give investors who claim to have been harmed by illegal trading priority over others. However, the plan also is expected to offer some relief to others, including the IRS.

A previous SEC-IRS dispute over the distribution of illegal trading profits was resolved through a compromise.