In Russia, the media covers James Rhodes and Pepper Potts' disclosure of their identities as Iron Man and Iron Woman, respectively. Ivan Vanko, whose father Anton Vanko—a former Stark Industries employee—has just died, sees this and begins building a miniature arc reactor similar to Rhodes and Potts'.

Six months later, Rhodes and Potts (honoring Tony Stark's legacy) have become media superstars and resist pressure to turn over their armored suits to the government. To continue the legacy of Stark and his father, Howard, they reinstitute the Stark Expo (renamed as Tony and Howard Stark Expo) in New York City's Flushing Meadows–Corona Park. Rhodes and Potts learn that the palladium core in their arc reactors is killing them due to overuse from the Iron Man and Iron Woman suits. Growing increasingly reckless and despondent about their impending deaths, and choosing not to tell anybody about their conditions, Rhodes and Potts agree to appoint the former's assistant Bambi Arbogast as CEO of Stark Industries and hires Stark employee Natalie Rushman to replace her as Rhodes' assistant.

Rhodes and Potts compete in the Monaco Historic Grand Prix, where they are attacked in the middle of the race by Vanko, who wields electrified whips powered by his arc reactor. Rhodes and Potts don their own armor and defeat Vanko, but their suits are severely damaged. Vanko explains that he intended to prove to the world that Iron Man and Iron Woman aren't invincible. Impressed by Vanko's performance, Rhodes and Potts' rival, Justin Hammer, fakes Vanko's death while breaking him out of prison and asks him to build a line of armored suits to upstage Rhodes and Potts, though Vanko decides that unmanned drones are a better idea. During what would have been Stark's forty-first birthday party and an celebration of the victory over Vanko, Rhodes and Potts get drunk while wearing the Iron Man and Iron Woman suits, respectively.

Disgusted, Stark's former bodyguard and chauffeur, U.S. Air Force Lieutenant Colonel Happy Hogan, dons Rhodes' prototype armor and try to restrain them. The fight ends in a stalemate, and Rhodes confiscates the armor for the U.S. Air Force. Nick Fury, director of S.H.I.E.L.D., approach Rhodes and Potts, revealing that "Rushman" is Agent Natasha Romanoff and that Howard Stark was the S.H.I.E.L.D. founder whom Fury knew personally. Fury explains that Vanko's father and Stark invented the arc reactor together, but when Anton tried to sell it, Stark had him deported. The Soviets sent Anton to the Gulag.

Fury gives Rhodes and Potts some of Howard's old material. In a diorama of the 1974 Stark Expo, Rhodes and Potts find a diagram of the atomic structure of a new element. With the aid of his A.I., J.A.R.V.I.S., Rhodes and Potts determine it can replace their arc reactors' current palladium core, thus allowing them to live without the worry of overusing Iron Man and Iron Woman suits again. When they learn that Vanko is still alive, they go to Hammer's expo. As Hammer unveils Vanko's armored drones, they are led by Hogan in a heavily weaponized version of the prototype armor, dubbed "War Machine". Just as Rhodes and Potts arrive to warn Hogan, Vanko takes remote control of all the drones and Hogan's armor and attacks Rhodes and Potts. Hammer is arrested for breaking Vanko out of prison while Romanoff and Rhodes and Potts' bodyguard Walt Hadfield go after Vanko at Hammer's factory.

Vanko escapes, but Romanoff returns control of Hogan's armor to him. Together, Rhodes, Potts, and Hogan defeat Vanko and his drones. Vanko dies by suicide by blowing up his suit along with the defeated drones. At a debriefing, Fury informs Rhodes and Potts because of their difficult personalities, S.H.I.E.L.D. intends to use them only as consultants. Rhodes, Potts, and Hogan receive medals for their heroism. In a series of mid and post-credits scenes, S.H.I.E.L.D. agent Phil Coulson reports the discovery of a large hammer at the bottom of a crater in a desert in New Mexico; Fury recruits astrophysicist Dr. Erik Selvig to discover the Tesseract's gamma signature; and Fury recruits Steve Rogers for a mission of worldwide ramifications.