The 17-time grand slam winner, who pulled out of last year's London showpiece with a back injury, went down 7-6 (7-3) 6-3 7-6 (7-5) in their third-round clash at the Paris Masters.
Federer had been seeking his seventh title this year, having beaten Rafael Nadal in last weekend's final of his home Swiss Indoors event in Basel.
Isner had never beaten Federer in a tie-break since they first met in 2007, but this time prevailed in both as he fired a total of 27 aces and clinched the final point with a serve of 145 mph.
Federer held his serve throughout the match against his 6-foot 10-inch opponent, and forced the only break in the second set.
"He's got the size, got the power, got the angles," the 34-year-old said. "He did very well today when he needed it. The breakers, he served great. Those are the ones he needed. That was the difference.
"It's tough to get out of the tournament not having lost your serve, but that's how it can go against John."
Federer, who is rarely injured, had to call for treatment after the recurrence of an arm problem he suffered in Basel.
"I felt it coming, so I just took some anti-inflammatories and I played with no pain in the third," he said. "That was not the reason for losing today. It's not serious, thankfully.
"I'm not worried at all. Now I have some days' rest, and if it's the last tournament of the year, it's going to be okay."
Isner's reward for his first tour victory over the world No. 2 -- his other win over Federer was in the 2012 Davis Cup -- is a quarterfinal against that year's Paris champion David Ferrer.
The only other top-three player Isner has ever beaten is Paris top seed Novak Djokovic, who faces a quarterfinal clash with Tomas Berdych on the other side of the draw after beating Frenchman Gilles Simon 6-3 7-5.
The Serbian is seeking to become the first player to win the tournament three years in a row, on top of his 2009 triumph, before defending his title at the November 15-22 ATP finale.
Like Federer, Kei Nishikori will have extra time to prepare for London after withdrawing from his third-round clash with Richard Gasquet.
Japan's world No. 7 was trailing the Frenchman 7-6 (7-3) 4-1 when an abdominal problem forced him to retire.
"After the first set, I started feeling my side abs. I couldn't really hit serves. I couldn't really hit 100%," the 25-year-old told reporters.
"If you're not 100%, it's not easy to beat Richard. I decided to not play.
"It should be okay in a few days. I will check later, but I will see how it goes these next couple of days."
Nishikori had to pull out in Basel last week with shoulder pain, and he believes a hectic schedule in 2015 could be the cause of his recent injury woes.
"I just need to recover for London," he said. "There's just one more tournament to go, so I need to recover soon and fight for another one."
Meanwhile, third-ranked Andy Murray has his eyes on Davis Cup glory -- especially after landing an important psychological blow in Paris on Thursday.
The Great Britain team's No. 1 thrashed final opponent Belgium's top player David Goffin 6-1 6-0 in just 53 minutes.
Both players will need to adjust from hard-court surfaces to the clay of Ghent when they next meet in the November 27-29 decider.
"Obviously clay is seen as being my worst surface, but I still feel like I play well on that court," said Murray, who will next play Gasquet in Paris.
"I don't know what speed the court's going to be (in Ghent). If it's quick, then I think that will help my serve a lot. If it's slow, then I feel like I can track a lot of balls down on the clay, which is positive.
"But it was good for me to get the chance to play him before the Davis Cup and see his game and the speed of his shots, where he maybe makes some mistakes from and things that he likes to do.
"Obviously with the result, that's a positive. Mentally for me it's a positive win."
Goffin remained philosophical in defeat. Ranked 16th, he cannot qualify for the eight-man finals in London, so will have longer to prepare for his country's first Davis Cup title match since 1904.
"Andy was extremely efficient today," said the 24-year-old. "As far as I was concerned, I thought this would be my last match of the season, so it's really tough to really put all your energy into it."