US president Barack Obama has authorised targeted airstrikes in Iraq to protect US personnel and Iraqi civilians.
Islamist militants are surging across the north of the country toward the capital of the Kurdish region, Erbil, sending tens of thousands of Christians fleeing for their lives.
Mr Obama said American warplanes would attack Islamic State "terrorist convoys" if they tried to advance on Erbil.
"In recent days these terrorists have continued to move across Iraq and have neared the city of Erbil where American diplomats and civilians serve at our consulate and American military personnel advise Iraqi forces," he said.
"I've directed our military to take targeted strikes against ISIL [Islamic State] terrorist convoys should they move toward the city. We intend to stay vigilant and take action if these terrorist forces threaten our personnel or facilities anywhere in Iraq including our consulate in Erbil and our embassy in Baghdad."
Watch Barack Obama's full statement here.
Mr Obama said warplanes could also be sent into action to save the lives of thousands of members of the Yazidi religious minority, who are trapped on a mountaintop after Islamic State fighters swept into their hometown.
"We can act, carefully and responsibly to prevent a potential act of genocide," he said.
"I therefore authorised targeted air strikes if necessary to help forces in Iraq as they fight to break the siege and protect the civilians trapped there."
But he was adamant that US combat troops "will not return to fight in Iraq".
Prime Minister Tony Abbott has backed Mr Obama's actions.
"This is a limited and targeted intervention to protect people facing a truly horrific future should they fall into the hands of this terrorist movement," Mr Abbott said.
A US defence official said US planes had already dropped water and food to the Yazidis stranded on Sinjar mountain.
The planes, which were escorted by combat jets, dropped 8,000 meals and water into Iraq and were over the drop area for just 15 minutes.
Photo: Islamic State (IS) militants stand guard near an IS flag after appearing to take control of a Kurdistan Democratic Party (KDP) headquarters in Bartella, northern Iraq, on Thursday (Reuters)
"We're also providing urgent assistance to Iraqi Government and Kurdish forces so they can more effectively wage the fight against ISIL," Mr Obama added.
Any US airstrikes would be the first in Iraq since a 2011 pull-out of troops.
But the Pentagon has already been forced to deny reports that warplanes have already gone into action.
"Press reports that US has conducted airstrikes in Iraq completely false," Rear Admiral John Kirby said in a post on his Twitter feed. "No such action taken."
An image from the Kurdish border area showed what appeared to be Islamic State fighters controlling a checkpoint at the semi-autonomous region, just 30 minutes' drive from Erbil, a city of 1.5 million that is headquarters of the Kurdish regional government and many businesses.
The fighters had raised the movement's black flag over the guard post.
However, a Kurdish security official denied the militants were in control of the Khazer checkpoint, and the regional government said its forces were advancing and would "defeat the terrorists," urging people to stay calm.
Minorities fear death at hands of militants
Earlier this week Islamic State militants captured Iraq's biggest Christian town, Qaraqosh, prompting many residents to flee, fearing they would be subjected to the same demands the Sunni militants made in other captured areas: leave, convert to Islam or face death.
The Islamic State, considered more extreme than Al Qaeda, sees Iraq's majority Shiites and minorities such as Christians and Yazidis, a Kurdish ethno-religious community, as infidels.
ISIS challenge to world order
As the US prepares for targeted air strikes against ISIS in Iraq, the fighting continues. The success of the Islamic State presents a challenge not just to the region but to world order, writes Ken Fraser.UN secretary-general Ban Ki-moon said he was "deeply appalled" by reports of attacks by Islamic State militants in Iraq and called on the international community to help the country's government.
The UN Security Council was due to hold an emergency meeting on the crisis.
French president Francois Hollande's office said, after he spoke by telephone with Kurdistan president Masoud Barzani, that Paris was prepared to support forces engaged in the defence of Iraqi Kurdistan. It did not say how.
The Islamic State said in a statement on its Twitter account that its fighters had seized 15 towns, the strategic Mosul dam on the Tigris River and a military base, in an offensive that began during the weekend.
Kurdish officials say their forces still control the dam, Iraq's biggest.
On Thursday, two witnesses said Islamic State fighters had hoisted the group's black flag over the dam, which could allow the militants to flood major cities or cut off significant water supplies and electricity.
The Kurdish Regional Government's Ministry of Interior said in a statement that "our victory is close."
Thousands stranded on Sinjar mountain
The militants' weekend capture of Sinjar, ancestral home of the Yazidi minority, prompted tens of thousands of people to flee to surrounding mountains, where they are at risk of starvation.
Yazidis, regarded by the Islamic State as "devil worshippers", risk being executed by the Sunni militants seeking to establish an Islamic Caliphate and redraw the map of the Middle East.
Some of the many thousands trapped on Sinjar mountain have been rescued in the past 24 hours, a spokesman for the UN Office for the Coordination of Humanitarian Affairs said, adding that 200,000 had fled the fighting.
"This is a tragedy of immense proportions, impacting the lives of hundreds of thousands of people," spokesman David Swanson said by telephone.
Many of the displaced people urgently need water, food, shelter and medicine, he said.
A spokesman for the UN agency for children said many of the children on the mountain were suffering from dehydration and at least 40 had died.
Thousands of Iraqis, most of them Yazidis, are streaming to the border with neighbouring Turkey to flee the fighting, Turkish officials said.
Gains by the Islamic State have raised concerns that militants across the Arab world will follow their cue.
During the weekend, the Sunni militants seized a border town in Lebanon, though they appear to have mostly withdrawn.
The Islamic State poses the biggest threat to Iraq's integrity since the fall of Saddam Hussein in 2003.
The group has deepened sectarian tensions, pushing the country back to the dark days of the civil war that peaked in 2006-2007 under US-led occupation.
