In Russia, the story begins as Tony Stark (Robert Downey Jr.), the CEO of Stark Industries, publicly reveals his identity as Iron Man. This revelation catches the attention of Ivan Vanko (Mickey Rourke), who, following the death of his father Anton Vanko—who had shared with him little more than his knowledge—embarks on his own quest for vengeance. In his father's final moments, Anton lamented that it should have been Ivan on that television instead of Tony. Armed with old blueprints for the arc reactor and a desire to carry on his father's legacy, Ivan begins to build his version of the technology.
Fast forward six months, and Tony has utilized his Iron Man suit to uphold world peace. He decides to recreate the Stark Expo in Flushing Meadows to honor his father's vision after it had last been held back in 1974. Using old recordings, Tony showcases his father's dream for a "city of the future." However, tensions rise as Senator Stern (Garry Shandling) insists that Tony must hand over the Iron Man technology to the government. In a show of strength, Justin Hammer, Tony's rival and head of the current military defense contractor, joins the Senate hearing along with Colonel James Rhodes (who would later be played by Don Cheadle).
Stark firmly rejects the idea of relinquishing his creations, asserting that the foreign competitors are still years away from replicating his success. Meanwhile, he is unknowingly battling a ticking clock; the palladium core in his arc reactor, a crucial power source, is poisoning him with toxicity levels rising dangerously. As the pressure mounts, he chooses not to confide in anyone about his deteriorating health.
Amidst his personal crisis, Tony promotes his assistant Pepper Potts (Gwyneth Paltrow) to CEO of Stark Industries, replacing her with Natalie Rushman (Scarlett Johansson) for public relations. When Tony travels to Monaco to compete in an F1 race, things take a dark turn as Ivan ambushes him with his own arc reactor-based weaponry. During the race, Vanko slices Tony's car in half, leading to a frantic rescue by Pepper and Happy, his bodyguard.
What follows is a brutal clash, revealing Ivan's connection to Tony's past through his father, Anton, and his motive for revenge stemming from a legacy of betrayal. Things grow chaotic as Justin Hammer tries to capitalize on this rivalry. He enlists Ivan to produce a line of combat suits to outshine Tony at the Stark Expo. Stark's birthday party spirals out of control when he gets intoxicated in his Iron Man suit, leading to yet another confrontation with Rhodes, who dons the Mark II armor.
As alliances shift and the stakes rise, Nick Fury (Samuel L. Jackson) arrives to reveal important secrets about the past, including the unknown legacy of Howard Stark that ties into the larger Avengers Initiative. With new information and a fresh element to replace the palladium, Tony fights against Vanko's drones and salvages the situation during the Iron Man Expo, leading to a climactic showdown.
In the end, after a fierce battle and resulting explosion, Vanko appears to be defeated, but not without leaving a significant impact on Tony's life and career, pushing Pepper to reconsider her role at Stark Industries. As the smoke clears, Fury discusses Tony’s potential yet warns that he himself may not be suitable to join the Avengers. Looking ahead, Tony Stark agrees to consult for the initiative while reflecting on his choices and the relentless pursuit of legacy, leading to a post-credits scene that teases future challenges with a mysterious hammer found in a crater.
