"There have been talks on ways Microsoft and AOL assets can be better leveraged and they've taken place over the normal course of business ...," the source said, calling reports of a joint venture "way overblown."
Although talks, which have taken place over several months, could advance, nothing was imminent, the source added.
Time Warner shares rose 2.7 percent after the New York Post (search) reported on Thursday the two were talking about a joint venture.
Time Warner declined comment. Microsoft was not immediately reachable.
Discussions started some two years ago after the companies settled a long-running antitrust suit that America Online (search), a unit of Time Warner, filed against the software giant, the source said.
Time Warner has been under pressure to boost its stock price, which has fallen 70 percent over the past five years. Corporate raider Carl Icahn (search) this week said he planned to seek one or more shareholder-nominated board seats at the company to force changes.
Icahn has demanded that the company raise its stock buyback program to $20 billion from Time Warner's existing commitments of up to $5 billion and completely spin off its cable division.
One investor was cheered by the discussions and said anything that could add some $4 per share to the stock price from improvements at AOL was a good sign.
"Management is not asleep at the switch," said Larry Haverty, a portfolio manager at Gabelli Asset Management, which has a stake of about $286 million in Time Warner.
"Anything you can do to move the needle in that direction is terrific for shareholders."
Low ball estimates for AOL are about $10 billion with improvements possibly doubling that valuation, Richard Greenfield, an analyst at Fulcrum Global Partners said.
Time Warner shares were up 55 cents at $18.47 in on the New York Stock Exchange.