A prestigious business award is given to Tony Stark, with a presentation that lays out his backstory. His father Howard worked on the Manhattan Project and then became a highly successful weapons developer, before he and his wife were killed in a car accident when Tony was still a boy. Howards partner Obadiah Stane took over the company and continued its success until Tony grew up and took it back, with his mechanical genius allowing it to reach whole new levels. The frivolous, alcoholic Tony skips out on actually receiving the award, leaving Stane to awkwardly cover for him.
Tony travels to Afghanistan with his friend and military liaison Colonel James Rhodes for a demonstration of his latest project, the Jericho missile. On the way back to base, the convoy is attacked and Tony is taken prisoner by a group called the Ten Rings, also receiving a near-fatal chest wound which they kidnap a doctor named Yinsen to cure. Hes only able to rig up a crude life support system with a magnet keeping the shrapnel from entering Tonys heart.
The groups apparent leader Raza demands Tony make a missile for him, and turns out to already have plenty of other Stark weapons. Instead, Tony comes up with a way to use his supplies to create a suit of armor with several weapons, along with a miniature arc reactor that can keep the shrapnel at bay. The suit is barely completed in time thanks to Yinsen distracting the guards by making a run for it, ultimately being killed which was his plan all along due to his family being killed during his kidnapping. Tony fights his way out, and blasts off into the desert where hes discovered by Rhodes.
Upon arriving back home, Tony announces to the press that after seeing his weapons in the hands of terrorists, hes shutting the whole division down, tanking his companys stock and leading the board to demand his resignation. He doesnt care at all, and turns his attention toward making a better version of the arc reactor, plus another metal suit. He gives the old reactor to his assistant Pepper Potts to dispose of, but instead she saves it to display in his workshop. After much trial and error, the new armor performs beautifully, but at high altitude develops an immobilizing ice buildup that requires another redesign. At the same time, Pepper is approached by Agent Phil Coulson of the Strategic Homeland Intervention, Enforcement and Logistics Division, who she keeps blowing off.
At a charity function, a reporter confronts Tony with how Stark weapons are still being used in atrocities in the Middle East, and Stane doesnt even bother to deny hes been continuing the same double-dealing behind Tonys back. Back at home, Tony sees a news report that even Yinsens village is being attacked by them, and in a rage he uses his handheld flight stabilizers to shoot a window out. This gives him an idea, and he soon flies to the village in his new armor, easily taking the terrorists out and also eluding a pair of American jets, in the process revealing to Rhodes what hes up to. Pepper also catches him removing the armor when he gets back.
Stane meets with Raza, revealing hed actually hired the Ten Rings to kill Tony only for them to go rogue when they learned who he was. Stane uses a device that causes temporary paralysis to get the better of Raza before killing him and all his men.
Tony sends Pepper to download files from Stanes office to find out the full scope of his dealings, and she finds a video from Raza revealing the whole scheme. Stane catches her in the act, but with some quick thinking she talks her way out and quickly gets to Coulson to tell him everything. Stane, frustrated at his science teams inability to duplicate the miniature arc reactor, resorts to using the paralysis device on Tony and pulling it out of his chest while ranting about his selfishness in keeping such a weapon to himself. Upon recovering, Tony is barely able to get to his workshop and reinstall the original reactor.
Pepper leads Coulson and his team into Stanes workshop, only to discover hes created his own much larger suit, the Iron Monger. Tony flies to the rescue, and despite being limited by the less powerful first arc reactor, hes able to trick Stane into following him to high altitude where the same ice buildup occurs. Unfortunately, Stane survives the fall and destroys much of Tonys suit, leaving him dangling helplessly on the company roof. Tony instructs Pepper in how to create a devastating pulse that will fry the whole roof, despite a major risk that it will kill him too, but fortunately hes thrown clear by the blast while Stane falls into the building in his disabled suit and is killed when the whole place explodes.
As Tony prepares to face the press about the incident, Coulson presents him with a cover story that will keep his identity as the newly named Iron Man secret, also adding that his organization can now simply be called SHIELD. But at the press conference, Tony goes off-script and outright tells the reporters he is indeed Iron Man.
Tony returns home to find an intruder: SHIELD director Nick Fury, who chides him for thinking hes the only hero in the world and introducing him to the Avenger Initiative.