Opponents of the Patient Protection and Affordable Care Act, in a widely watched case Tuesday, urged a divided panel of appeals judges in Washington to adopt a legal analysis that would essentially gut federal insurance subsidies in 36 states. And signs surfaced suggesting that analysis may win the day.

In the case of Halbig v. Sebelius, the U.S. Circuit Court in Washington heard from lawyers for seven private citizens and businesses who say the Internal Revenue Service illegally interpreted the reform law to allow federal subsidies for any U.S. citizen who meets income criteria. The law says subsidies go only to citizens in states with their own exchanges, but 36 states did not set up their own exchanges.

The IRS implements the subsidy rules because the financial support is distributed through refundable tax credits. The federal agency looked at the law and interpreted it to mean anyone in any state was eligible for subsidies to afford insurance, and anything to the contrary was essentially a drafting error because Congress always intended to extend insurance coverage as widely as possible.

“Their argument is, Congress was so devoted to distributing these subsidies as widely as possible, you are to ignore the plain language in the subsidies provision” of the reform law, Jones Day attorney Michael Carvin told the three-judge panel of the D.C. Circuit court Tuesday, arguing on behalf critics of the law.

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Carvin said the limits on the subsidies were intended as a “carrot” to encourage states to set up their own exchanges — a position that was attacked by Senior Circuit Judge Harry Edwards.

“When I read that argument, to be very honest with you so you know what my concerns are: It seems preposterous,” Judge Edwards told Mr. Carvin during the hearing. “No one assumed that if you choose not to create the exchange, you'll effectively gut the statute.”

But the two other judges on the panel, Thomas Griffith and Raymond Randolph, made statements more sympathetic to the IRS' critics. The American Hospital Association, which filed a brief supporting the IRS, said in its daily bulletin to hospital members that Judges Randolph and Griffith “appeared to agree” with Mr. Carvin's arguments.

Before they can overturn the wording of the reform law, the judges will have to conclude that the statute contains some level of ambiguity about what was intended, said healthcare attorney Elizabeth Mills of Proskauer Rose in Chicago. The judges could also consider whether congressional gridlock prevented lawmakers from making small wording amendments since the law's passage almost four years ago.

“You have to find that it's ambiguous first. And I think that is where the parties are disagreeing,” she said.

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There's a good chance that the eventual decision will be appealed to the Supreme Court. But whether the court would take the case could depend on how other courts rule.

Four cases are pending on the issue of tax subsidies in federally run insurance exchanges. To date, only two rulings have been published, both coming down in favor of the IRS' interpretation. The 4th U.S. Circuit Court of Appeals is scheduled to hear oral arguments May 15 in the case King v. Sebelius, in which Mr. Carvin will make the same case he made to the D.C. Circuit.

Typically, the Supreme Court accepts cases when circuit judges reach different or split decisions on the same law, which means the court might not be as interested if the D.C. and 4th Circuits reach the same decision.

However, the lawyer for the Competitive Enterprise Institute, which is footing a majority of the legal costs in both cases, said the Supreme Court may take up the issue regardless of lower court rulings.

“A lot depends on how the rulings come out, when they come out, and who they favor,” said Sam Kazman, attorney for the CEI. But “frankly, I think it is a major enough issue that there is a good likelihood that it will go there even if there is no split.”

Joe Carlson writes for Modern Healthcare, a sister publication of Business Insurance.