United had been the better side and went ahead in front of the massive 75,000 crowd in the first half through Paul Scholes.
Andrei Shevchenko then levelled to send the match to penalties which went on for some time, despite early misses by Roy Keane and Hernan Crespo.
The deciding kick was to be Tim Howard's, but the United goalkeeper could only send the 20th kick on to the post - which gave Milan victory.
The Serie A giants, barring former United star Jaap Stam - were at full strength, while United were themselves fielding their best team of their trip with Scholes and Mikael Silvestre both starting after flying in this week.
Milan looked comfortable in the opening exchanges and should have taken the lead through Paolo Maldini after five minutes, but he headed wide.
Wes Brown then headed wide from a Ryan Giggs set piece as they came back into the game.
After a bout of sustained pressure, United then went ahead through the ubiquitous Scholes.
French starlet David Bellion created the goal as he crossed in from the right flank, Alessandro Nesta could not deal with the ball and could only back heel it into the path of Scholes - who hammered an effort past the helpless Dida.
United then controlled the game and Scholes and Giggs both went close.
Milan - who are some weeks behind United in terms of their pre-season preparations - could have grabbed an unlikely equaliser just after the hour mark.
Cafu embarked on an archetypal marauding run down the right and he cut the ball back for Crespo - but the on loan Chelsea striker saw his back-heeled effort brilliantly saved by Tim Howard in the United goal.
At this point Sir Alex Ferguson took the opportunity to bring some more of his younger squad members into the game and two almost got their names on the scoresheet.
The first was Chris Eagles who broke in from the right before hammering wide and then Kieran Richardson from the opposite side saw his fizzing effort find the side netting.
United looked very solid, but with just seconds remaining - Milan grabbed a somewhat undeserved leveller.
Shevchenko won a free kick down the right when he went to ground following a challenge from Wes Brown. The Ukrainian worked his way into the area and found himself on the end of Kaka's free kick and he fired past Howard.
The goal meant the game would be decided on penalties, which Milan won - United's second penalty defeat on the tour.
