The Seventh U.S. Circuit Court of Appeals ruled the measure deprives Medicaid patients of their right to obtain medical care from the provider of their choice, The Wall Street Journal reported Wednesday.
Federal law already prohibits states from using federal funds to pay for most abortions.
However, the Indiana law goes further by barring state-administered funds for any organization that performs abortions even if the money is earmarked for other services.
Planned Parenthood sued to block the Indiana law after it was passed.
In addition to abortions, the organization provides low-income patients with a range of other services including cancer screening, treatment for sexually transmitted diseases and prenatal care.
The Chicago court ruling contrasts with an August decision by the Fifth U.S. Circuit Court of Appeals in New Orleans upholding a Texas law that de-funded Planned Parenthood and other abortion providers.