As Tony Stark reveals to the world that he is Iron Man, in Russia Anton Vanko died after telling his son Ivan to use what he had been taught. Six months later, Stark has used his Iron Man armor to bring about a negotiated peace between the major super powers of the world, and his immense popularity with the general public is only furthered when he fulfills his father's dream by opening the "Stark Expo", to showcase all the latest inventions that will benefit the world. Stark is, however, still vilified by the United States government, and Senator Stern in particular, who demands that he hand his armor technology over for military application. Stark refuses, publicly shaming rival Justin Hammer in the process by highlighting his own failed attempts at recreating the technology. All is not well in Stark's life, however: he has discovered that the palladium in the arc reactor keeping his heart beating has begun to poison his body, slowly killing him, and all attempts to find a substitute element have failed. Slowly going off the rails as a consequence of what he believes to be his impending death, he appoints his former personal assistantPepper Potts CEO of Stark Industries, replacing her with Natalie Rushman.
While racing in Monaco, Stark is attacked by Ivan Vanko, who has constructed a miniaturized arc reactor of his own, including whip-like attachments harnessing the electrical energy. Defeating Vanko with the aid of his Mark V armor (a transforming briefcase), Stark discovers that Vanko is the son of disgraced Russian physicist Anton Vanko, who collaborated on the first arc reactor with Stark's father Howard. Vanko is promptly broken out of jail by a revenge-seeking Justin Hammer, who puts him to work fashioning a line of armored combat suits that he will use to upstage Stark at his own Expo.
Tony throws what he believes will be his last birthday party and promptly proceeds to get drunk whilst wearing the Mark IV armor, forcing his friend Lt. Colonel James Rhodes to don the Mark II armor and subdue him. Disgraced, Stark is approached by Nick Fury of S.H.I.E.L.D., who provides him with a chest of his father's old artifacts that can hopefully be used to find a cure for his palladium poisoning. Reviewing the film reels in the chest, Stark discovers a message from his father that leads him to the original 1974 diorama of the Stark Expo: in reality, a disguised diagram for the molecular structure of a new element. Stark hand-builds a particle accelerator with the aid of his computer J.A.R.V.I.S. and synthesizes this new element, creating a new triangular chest arc that cures his poisoning.
Simultaneously, at Stark Expo, Hammer unveils his new military drones, captained by Rhodes in a heavily-weaponized version of the confiscated Mark II armor. Unfortunately, it is soon discovered that Vanko has complete control of both the drones and Rhodes's new armor, and Stark arrives just as they go on the attack. As Stark battles against these remote-controlled enemies, Happy Hogan and Natalie (an undercover S.H.I.E.L.D. agent named Natalia Romanoff) race to Hammer's Queens facility to stop Vanko. By they time they arrive, Vanko has already departed for the Expo in a new, more powerful suit of armor, but Natalie is able to give Rhodes control of his armor again so that he and Stark can fight Vanko together. The two armored allies combine their powers and successfully take Vanko down, but his armor and Hammer's Drones are revealed to have been equipped with self-destruct charges. As they begin to go off, Stark races to save Pepper, rescuing her at the last minute. She quits her CEO position, and she finally gives Tony a kiss.
At a debriefing, Fury informs Stark that while Stark is "unsuitable" for the Avengers Initiative, S.H.I.E.L.D. wants Iron Man as a consultant. Stark agrees on the condition that Senator Stern present him and Col. Rhodes with their medals for bravery.
In a post-credits scene, S.H.I.E.L.D. agent Coulson is seen driving to a remote impact crater in the New Mexico desert. Over a phone, he informs Fury that they've "found it". The camera then pans from the opposite side's view and Thor's hammer is seen and thunder is heard as the screen fades to black.
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