A few months after revealing to the public that he is Iron Man, Tony is being confronted by the government to hand over the technology of the suit to be used by what they consider a more responsible user. Tony defends his technology from the government and in the meantime running the Stark Expo, an event showing the world new advances in technology. What he is keeping secret is that the palladium in Tony's Arc Reactor is slowly killing him. He has made attempts to find an alternative element to power the Reactor, but to no avail. Tony begins to gradually set affairs in order by making Pepper CEO of the company and is replaced by Natalie Rushman, as an assistant for Stark.
While racing his car in the Circuit De Monaco, Tony is attacked by Ivan Vanko, who slices Tony's car in half with his energized whips. With quick thinking and the help Pepper, Happy and a portable suit, Tony defeats Vanko and he is taken in. Tony realizes that Vanko has an Arc Reactor of his own, so he confronts Vanko asking where he obtained this technology, and Vanko replies it was a design made by his father, Anton Vanko. Vanko then threatens that soon the Stark name and his world wil crumble around him. He also knows that the Arc Reactor is killing him. after talking with Tony, Vanko manages to fake his death and go into hiding, working for Tony's rival, Justin Hammer, to create a unit of Iron Men drones.
As Tony feels the end coming towards him, he begins a self destructive path. He arranges a party and he gets drunk in his Iron Man suit, firing pulse blasts at tossed objects for target practice. Jim Rhodes arrives and realizes that Tony is endangering all of the people at the party, due to his recklessness. Rhodes dons the Mark II suit and cofronts Tony, evacuating the house and get into a brawl that results in a large amount of Tony's home being wrecked. After the fight, Rhodes flies off to the military with the Mark II suit.
Tony is later found by Nick Fury and admits that he was being monitored by one of his agents, Natalie Rushman who is actually Natasha Romanoff. Fury tells Tony that his father, Howard Stark was one of the founders of S.H.I.E.L.D. and used to work with Ivan's father, who wanted to use the Arc Reactor for personal gain ( the reason that Vanko is after the Stark name is because of what happened to his father). Fury also provides Tony with some old videos of his father to point him the right direction.
After Tony tries to reconcile with Pepper about his behavior, He discovers a secret formula in a diarama of the Stark Expo, finding a new element. Tony sets up a device to harness its power and manages to use it as an alternative source of power for a new Arc Reactor. Tony is contacted by Vanko, revealing that he is still alive, and plans to attack at the Stark Expo.
When Tony arrives he realizes that Hammer and Vanko have made a garrison of Robotic drones based on his design as well as a new, upgraded Mark II suit being used by Rhodes. Vanko overrides the drones and Rhodes' suit to attack Tony, leading to a pursuit over the city. With the help of Pepper, Natasha, and Happy, they let Rhodes regain control and help Tony fight off the drones. Vanko arrives in an improved suit of his own and fights the both of them. Tony and Rhodes work together to take down Vanko and in a last ditch effort to kill Stark, Vanko activates a self-destruct system on himself and his drones. Tony flies off to save Pepper from the explosions and after the chaos they kiss and make up, and Pepper steps down as CEO so Tony can take over.
Tony and Rhodes are later awarded with medals for their achievements.