The al Qaeda offshoot, which poses the biggest security threat to Iraq since the fall of Saddam in 2003, has made new bold advances in the north, reaching a major dam and seizing a fifth oilfield and three more towns after routing security forces from the Kurdish autonomous region.
But some Iraqi intelligence and security officials are far more alarmed by the Islamic State's less heralded campaign in rural areas just south of the capital, rugged Euphrates valley terrain once known to U.S. forces as the "triangle of death".
While the Islamic State's march on Baghdad from the north has been halted near the town of Samarra 100 km (60 miles) from the city limits, the fighters have more quietly building up their forces on the capital's southern outskirts.
"We told the government that urgent military operations are essential to prevent the Islamic State from taking over further towns south of Baghdad; otherwise they will be very close to the capital," said Falah al-Radhi, head of a security panel in the provincial council of Hilla, the province just south of Baghdad.
For several weeks, the Sunni insurgents have been moving fighters, weapons and supplies from strongholds in western Iraq through secret desert tunnels to the town of Jurf al-Sakhar, about 60 km (40 miles) south of Baghdad.
Built by Saddam in the 1990s to hide weapons from U.N. weapons inspectors, the tunnels are also ideal hiding places that allow fighters to avoid military helicopters.
Islamic State militants occupying the city of Falluja and parts of Ramadi, where U.S. troops once faced a stubborn al Qaeda insurgency, access the tunnels from an area near military facilities once used by Saddam's troops.
"It makes it impossible for us to control this area," said an intelligence official, describing Jurf al-Sakhar and nearby towns just south of the capital.
The towns south of Baghdad and the surrounding lush, irrigated fields - a religiously mixed area where the mainly Sunni upper Euphrates valley meets the river's mainly Shi'ite lower reaches - formed one of the most violent parts of Iraq under U.S. occupation.
The territory, with its canals, ditches and thick vegetation, provides ideal cover for insurgents.
U.S. military and Iraqi security officials estimate the Islamic State has at least 3,000 fighters in Iraq, rising towards 20,000 when new recruits since June's advance are included.
In the north, Iraq's army virtually collapsed when the Islamic State staged a lighting advance in June, capturing the cities of Mosul and Tikrit and a number of towns. The group also controls much of the west. It has declared a caliphate in areas it controls in both Iraq and Syria, vowing to march on Baghdad.
Capturing Baghdad would be difficult: the capital is home to thousands of elite forces as well as a vast number of Shi'ite militia fighters. But seizing towns on the southern perimeter would let the Islamic State step up suicide and car bomb attacks in the capital and perhaps restart the urban warfare of 2006-07 when Sunni and Shi'ite militia battled street by street.
ASSAULT ON JURF AL-SAKHAR
In late July, 400 Islamic State fighters arrived in Jurf al-Sakhar for an assault on the Euphrates riverside town, described by a senior official in the provincial capital Hilla.
Two-hundred mortars were fired at the town. Suicide bombers driving captured U.S.-made Humvees blew themselves up. Several police stations and the mayor's office were taken over.
Six Islamic State gunmen who were captured told interrogators that the insurgents planned to open new fronts in the nearby towns of Mussayab, Yusufiya and Jbala, the official said.
Fighters in the area are using rough terrain to evade death and capture: swamps, high reeds, bushes and irrigation canals that military vehicles can't traverse.
Desperate to gain an upper hand, the army has started to pound the terrain with "barrel bombs" - drums filled with explosives or fuel dropped from the air.
"Islamic State fighters swept the town and kicked out security forces, and to regain control we need to deal with around 10,000 acres of farmland area," said a military colonel.
"We have stared to follow a scorched earth policy. This is tough, we know, but army helicopters should have clear vision to chase and destroy them."
Officials fear that further gains by the Islamic State will give the group control of key roads linking Baghdad to southern cities in the Shi'ite heartland, including the holy cities of Kerbala and Najaf, which the fighters have declared targets.
Shi'ite families in towns south of Baghdad are not taking any chances. Hundreds have already fled. Islamic State fighters, who consider all Shi'ites infidels deserving of death, have made their intentions clear.
"It was a horrible day when I saw the threatening leaflet with the Islamic State logo. Leave your house or we will slaughter anybody we catch," said Kadhum al-Yasiri, a Shi'ite who fled his fish farm fearing his family would be beheaded.
"It took me only an hour to flee Jurf al-Sakhar with my wife and four sons. The horrible fear of getting my head decapitated stopped only when I reached a safe haven."
While Shi'ites live in fear of the Islamic State, Sunnis in towns near Baghdad are growing increasingly resentful of government forces backed by Shi'ite militias they accuse of kidnapping and killing.
In the town of Yusufiya, just 20 km (12 miles) south of Baghdad, government forces are fighting what they say are Islamic State sleeper cells.
Sunni residents say troops who have set up checkpoints and watchtowers have completely alienated residents, including a group of 50 tribesmen armed with rocket-propelled grenades, roadside bombs and even anti-aircraft machineguns.
Local tribal leader Abu Shakir said Sunnis had tried to improve relations with the army, sending a small delegation to tell officers that the townspeople had no problem with the military, just the sectarian policies of Prime Minister Nuri al-Maliki's Shi'ite-led government. Relations only deteriorated.
"Tribes started to form armed groups to fight the government forces and all groups have one objective: marching toward Baghdad to bring down Maliki's government," he said.
Abu Tabarak, from the nearby town of al-Rasheed, said he would be happy to work with the Islamic State.
"We are confident when we look to the facts on ground that Maliki's forces will not be able to keep fighting on more than one front and that is what is happening now," he said.
"At a certain point there will be a sudden collapse on one of the fronts, which will be the chance that tribal fighters will never miss to approach Baghdad."