The reversal is an embarrassment for the department, which won a conviction against the Alaska Republican in October and is now asking to overturn it.
The week after his conviction, Stevens lost his Senate seat in the November election. The patriarch of Alaska politics since before statehood, Stevens, 85, was also the longest serving Republican senator.
He has been awaiting sentencing.
Stevens was convicted of seven felony counts of lying on Senate financial disclosure forms to conceal hundreds of thousands of dollars in gifts and home renovations from a wealthy oil contractor.
The trial was beset by government missteps, which continued even after the guilty verdict was read. The trial judge grew so infuriated he took the unusual step of holding the Justice Department in contempt.
In court filings, the Justice Department admitted it never turned over notes from an interview with the oil contractor, who estimated the value of the renovation work as far less than he testified at trial.
"I have determined that it is in the interest of justice to dismiss the indictment and not proceed with a new trial," Attorney General Eric Holder said in a statement released Wednesday. He said the department must ensure that all cases are "handled fairly and consistent with its commitment to justice."
The Justice Department is investigating the conduct of the prosecutors who tried the Stevens case.
Sen. Mark Begich, the Democrat who won Stevens' seat away from him, called the decision to drop the case "reasonable."
"I didn't think Senator Stevens should serve time in jail and hopefully this decision ensures that is the case," Begich said in a statement.
In December, Stevens asked a federal judge to grant him a new trial or throw out the case, saying his trial had many deficiencies.
U.S. District Judge Emmet Sullivan held Justice Department lawyers in contempt in February for failing to turn over documents as ordered. He called their behavior "outrageous."
Sullivan had ordered Justice to provide the agency's internal communications regarding a whistle-blower complaint brought by an FBI agent involved in the investigation of Stevens. The agent objected to Justice Department tactics during the trial, including failure to turn over evidence and an "inappropriate relationship" between the lead agent on the case and the prosecution's star witness.
The Justice Department has since assigned a new team of prosecutors to the case.
Reached at his office early Wednesday by the Anchorage Daily News, Stevens' lawyer, Brendan Sullivan, told the newspaper he had not yet been informed of the decision by Justice.
Messages for Stevens' lawyers from The Associated Press were not returned early Wednesday morning.
The decision was first reported Wednesday by National Public Radio.