The court ruled six-to-three to uphold the only state to let doctors prescribe lethal medication to terminally ill patients who want to end their lives.
The ruling ended a battle waged by religious groups and conservative Republicans against Oregon's "Death with Dignity" law.
In 2001, Attorney General John Ashcroft, a staunch conservative, issued a directive against Oregon's law, arguing that assisted suicide was not a "legitimate medical purpose."
Mr Ashcroft, who has since stood down, argued that the law violated the Controlled Substances Act and he would authorise federal drug enforcement agents to punish doctors who prescribed lethal drug doses to terminally ill people.
But the Supreme Court ruled that federal laws do not authorise the US attorney general "to bar dispensing controlled substances for assisted suicide in the face of a state medical regime permitting such conduct."
A lower court had earlier blocked the government move.
The decision focused more on the differing rights of the federal government and states to regulate medical practices, than on the overall legality of assisted suicide.
Opponents disappointed
The Justice Department said it was "disappointed" by the ruling.
"The Department of Justice remains committed to enforcing our nation's laws and ensuring that drugs are not diverted to unlawful uses," Justice Department spokeswoman Tasia Scolinos said in a statement.
The ruling was cheered by assisted suicide advocates.
"This is really a tremendous ruling on the part the Supreme Court upholding the rights of terminally ill patients to control their end of life care," said Robert Kenneth, director of communications for Death With Dignity, which fought to defend the Oregon law.
"It is also an affirmation of state's authority to monitor regulate and determine legitimate medical practice," Mr Kenneth said.
But he noted that the ruling "does not discuss any kind of constitutional right to die."
"It is simply a case of whether or not a federal government can interfere in medical practice under the auspices of the Controlled Substances Act," Mr Kenneth said.
Judge’s decision
Justice Anthony Kennedy, who is seen as a moderate member of the Supreme Court, wrote for the majority.
Voting in the minority for the government view was the court's newest member, John Roberts, who was appointed chief justice by Bush last September.
He was joined by justices Clarence Thomas and Antonin Scalia, who are considered the most conservative members of the court.
Oregon instituted the nation's only law allowing physician-assisted suicide in 1997, backed by two statewide votes in favor of it.
Between 1997 and 2004, the latest year for which data is available, 208 killed themselves under the "Death with Dignity" law.
The law strictly regulates the practice, requiring that the patient wishing to die has an incurable or irreversible condition that would result in death within six months.
The law also requires that two doctors evaluate the patient, to be sure he qualifies and is cognisant of the decision to die and fully willing before the prescription can be approved.