The $3.5 million question of the week: What will Miramax do with its “Kids”?

After only one sneak-preview midnight screening last month at the Sundance Film Festival, Larry Clark’s graphic, provocative film about New York street teens has the industry puzzling over how Miramax will market – or even distribute – the picture and keep to the “no NC-17” rule of its owner, the Disney Co.

“Kids,” which is poised to become one of the most controversial American films ever made, is so sexually frank that some feel it is practically the film for which the adult rating was invented. The picture is, blatantly, about sex, in word and deed, as it chronicles the movements of a number of teenagers over the course of one day and night, including considerable drug use, numerous hot and realistic sex scenes that are staged at length, and constant, extremely raw sex talk.

“This,” says an insider, “is going to be the mother of all holy ratings wars.”

The stakes are high: Miramax co-chairmen Bob and Harvey Weinstein paid a hefty $3.5 million for the worldwide distribution rights. And while their company has built a reputation for turning controversy into coin, it’s hamstrung by Disney’s refusal to release NC-17-rated films. Disney cannot release an unrated film as a member of the Motion Picture Association of America.

Miramax and Disney found themselves in a similar situation with the Martin Lawrence starrer “You So Crazy” when an NC-17 rating pushed the film from the studio to Samuel Goldwyn. “You So Crazy” was released unrated.

“Kids” has not yet been rated, and sources at Miramax caution that the cut shown at Sundance may yet be changed (the screening was scheduled by producers before Miramax bought the rights), although there was nothing unfinished-looking about the editing and full front-and-end credits, nor temporary-sounding about the soundtrack.

Rival indies are predicting that this is the film that could put the Disney-Miramax relationship to its toughest test yet.

“The joke going around,” says one Gotham indie insider, “is that when Disney first heard Miramax bought a movie about kids, they must have thought ‘Great, Miramax is finally on board. We see theme park rides.”

The road leading from the Sundance screening to commercial release would seem to more resemble a battlefield, one marked by at least four major obstacles: Disney, the MPAA, official opinion as expressed by politicians, religious leaders and the press, and exhibitors. On each front, the fight will generate increasing publicity, but there are those within the distribution community, especially among Miramax’s competitors, who doubt that the Weinsteins can go all the way with this one.

The slice-of-life film chronicles 24 hours in the lives of a number of urban teens who hang out on the streets and relentlessly pursue kicks, with particular focus on two boys and one girl. One of the boys, who looks about 16, is proudly known as “the virgin surgeon” for his skill at deflowering girls, and demonstrates his specialty in the opening scene with a very young-looking blonde, and again near the end with another teenager. Both scenes feature full-frontal nudity of the girls and plenty of bumping-and-grinding, although no male genitalia.

Clark, a photographer best known for his 1971 underground photo book “Tulsa,” has often used junkies, prostitutes and teenagers as his subjects, and undertook his helming debut after photographing teen skateboarders in Gotham.

The screening at Sundance was not officially announced. Opinion was divided as to the film’s artistic merits, with many lauding its realism and daring and others terming it exploitative, but there was general consensus that it crosses a new boundary in terms of its frank depiction of teenage sex and drug use. Relatively few members of the press were in attendance. Those on hand, including a Variety critic, agreed that everything else at the fest paled by comparison.

The AIDS virus is introduced as an underlying threat to all the characters, and those defending the film on moral grounds will make the case that it’s like a cautionary, live-action “Just Say No” poster – that its intention is to shake and scare the public into an awareness that there is a big problem out there with unsupervised kids who lack the maturity and moral guidance to restrain their own behavior.

But others will insist it is exploitation pure and simple, bordering on kiddie porn.

Either way, feelings are strong. “I don’t like this movie,” says a longtime indie vet, “and I don’t like it as a parent.”

Counters a distribution exec, “‘Kids’ made everything else at Sundance look like amateur hour.”

When not indulging in sex or drugs, kids in the film, who are interracial but predominantly white, viciously beat up a black man in Washington Square Park, and also do some gay-baiting. Several preteen boys are seen at length smoking joints.

Disney sources say Mouse House execs are more than a little baffled by the latest Weinstein purchase, although no one at the studio would comment.

Ratings skirmishes have become commonplace for Miramax, but “Kids” is stirring talk of a different sort. Although Miramax and the film’s producers insist the young stars of the disturbing film – real street kids, not actors – are at least 18 years old, many viewers at Sundance were skeptical.

Mike Chambers, a Manhattan-based exec producer of the film, says that while the film’s actors ranged in age from 16 to 20, “everybody involved in sexual situations was over 18.” Chambers says producers used “standard ways of proving age” such as birth certificates and passports. End credits do indicate the use of body doubles.

A spokeswoman for Miramax says the company is certain that the kids were of legal age. No one at the company would comment further about the film. Attempts to reach Clark and the cast were unsuccessful.

Sources say Harvey Weinstein, who was aware of the project in script stage for two years before it was made, went after “Kids” with his trademark take-no-prisoners approach. Other distribs, particularly October Films, were interested in acquiring distribution rights but didn’t even get the chance to make a bid.

What Weinstein eventually releases is anybody’s guess. Miramax is calling the film a “work in progress.” Still, some say “Kids” presents a challenge even to Harvey Weinstein’s formidable editing skills, as the heavy sex content runs throughout the film and isn’t confined to one scene, as it was in “Clerks,” the last pic on which Miramax fought (successfully) an NC-17 rating.

Asked about possible editing, Chambers says only “That’s up to Miramax.”

“Kids” marks the first major entry into film for the 26-year-old Chambers and 28-year-old Patrick Panzarella. The two are partners in C&P Capital Inc., a New York based capital investment company that owns NG Records (a small punk rock label) and manages Nashville country singer Tamara Walker. The duo’s only other film project was last year’s “Jim Rose Circus Sideshow,” a direct-to-video release in the U.S. described by Chambers as “a freak show movie.”

After being approached by “Kids” producer Cary Woods, C&P put up an undisclosed sum, scoring an exec producing credit along with filmmaker Gus Van Sant (Van Sant cinematographer Eric Edwards was the d.p. on “Kids”). Ace New York low-budget producer Christine Vachon (“Poison,” “Swoon”) came on board as line producer. Woods declined comment.

Although the production team has been the subject of rumored disagreements over the film’s content, Chambers insists he is not nervous about the expected controversy. “We did the movie because we felt America is asleep. We hope to wake everyone up.”