U.S. District Court Judge Henry E. Hudson denied a motion brought by lawyers for the administration to dismiss the lawsuit, filed by Virginia in March, a day after Obama signed into law federal health legislation.
"While this case raises a host of complex constitutional issues, all seem to distill to the single question of whether or not Congress has the power to regulate -- and tax -- a citizen's decision not to participate in interstate commerce," wrote Hudson in his 32-page memorandum.
"Given the presence of some authority arguably supporting the theory underlying each side's position, this court cannot conclude at this stage that the complaint fails to state a cause of action," he wrote.
Hudson said the case cannot be resolved without a further hearing on the merits.
While the legal battle over the Patient Protection and Affordable Care Act ultimately is expected to end up in the U.S. Supreme Court, today's ruling is a setback for the administration, which also faces a separate but similar legal challenge to health reform filed by Florida on behalf of 20 states.