Acting U.S. Attorney Audrey Strauss in Manhattan said the settlement related to seven cross-border transactions between the insurer's AIG Financial Products unit and foreign banks dating from the mid-1990s.
She said there was "overwhelming evidence" that the seven transactions had no economic substance, and were designed to generate bogus foreign tax credits to reduce AIG's U.S. tax liabilities for the 1997 tax year.
AIG had filed a lawsuit in 2009 challenging an Internal Revenue Service decision from the prior year to disallow the tax credits and impose a 20% tax penalty.
But the government said the seven transactions enabled the New York-based insurer to "game" the tax system by exploiting differences between foreign and U.S. tax laws, and "sucked hundreds of millions of dollars" from the U.S. Treasury.
"AIG created an elaborate series of sham transactions that were designed to do nothing--and in fact did nothing--other than generate hundreds of millions of dollars in ill-gotten tax benefits," Strauss said in a statement.
The settlement was approved on Thursday by U.S. District Judge Louis Stanton in Manhattan.
AIG was allowed to keep some income expense deductions, and remove some amounts related to the transactions from its taxable income. It had reached a nonbinding settlement in principle in January 2018.
"We are pleased to put this longstanding matter behind us," AIG said in a statement.
The case is American International Group Inc et al v U.S., U.S. District Court, Southern District of New York, No. 09-01871.
(Reporting by Jonathan Stempel in New York; editing by Jonathan Oatis)
By Jonathan Stempel