Two years after the death of Chucky, the remains of the doll are recovered and reassembled by the Play Pals Corporation, the producer of the Good Guy dolls, to reassure its stockholders after the negative publicity from the murders. During the process a power surge occurs and one of the assembly line workers is killed by electrocution. Mr. Sullivan, the executive of the company, orders his assistant Mattson to cover up the accident and dispose of Chucky, unaware that the doll has been brought back to life by the accident.
Meanwhile, Andy, who is now eight years old, has been in foster care ever since the murders; his mother is in a mental institution, having been pronounced mentally unstable for supporting his story about Chucky. Andy is adopted by Phil and Joanne Simpson, who have already adopted Kyle, a cynical teenage girl. Chucky soon discovers Andy’s whereabouts by using Mattson’s car phone to call Grace Poole, the manager of Andy’s foster center, before hijacking his car at gunpoint and suffocating him with a plastic bag after he reaches the Simpson house. Chucky infiltrates the home by destroying another Good Guy doll called “Tommy” and replacing it with himself.
After Chucky destroys an heirloom which Joanne forbade the kids to touch, Phil punishes both Andy and Kyle for smashing Joanne’s ornament. Andy spends the rest of the day bonding with Kyle, initially believing Chucky to be an ordinary Good Guy doll. That night, Chucky ties Andy to his bed and reveals himself, but Kyle enters the room before he can complete the ritual to possess him. Kyle disbelieves Andy’s assertions about Chucky while Phil and Joanne believe Kyle to be responsible and throw Chucky in the basement, where he realizes that he is becoming human after suffering a nosebleed.
The next day, Chucky secretly follows Andy to school. Andy’s teacher, Miss Kettlewell, forces him to stay after school for detention after Chucky defaces his homework with vulgarity. Chucky beats Miss Kettlewell to death with a yardstick, but Andy manages to escape. Later, Andy tries to tell his foster parents about Chucky, but Phil refused to believe him and considers returning him to the foster center.
That night, Andy sneaks into the basement to destroy Chucky with an electric knife, but Chucky overpowers him. When Phil arrives to investigate the commotion, Chucky trips him, causing Phil to fall to his death. After finding Phil, Joanne immediately assumes Andy to be responsible and promptly sends him back to the foster center. Kyle discovers “Tommy” buried in the garden and realizes Andy was telling the truth. She rushes to warn Joanne, whom Chucky has already killed. Chucky ambushes Kyle and forces her to drive him to the foster center where Andy has been sent.
At the foster center, Chucky clears the building by pulling the fire alarm. He stabs Grace to death and forces Andy to take him to the Play Pals toy factory for the transfer. Kyle pursues them to the factory, where Chucky knocks Andy unconscious and completes the ritual; unfortunately he suffers another nosebleed, realizing it’s too late to transfer his soul into Andy and is now permanently trapped inside the doll, much to his despair. Enraged, he goes after both Andy and Kyle, intending to kill them. As Andy and Kyle search for an exit and Chucky chases them over the machinery, Kyle slams a gate shut on Chucky’s hand, which Chucky tears off and replaces with a makeshift blade.
After Chucky murders a factory technician, Kyle and Andy knock the doll into some machinery that mutilates him by attaching numerous arms and legs to his torso. Chucky escapes from the machinery by cutting off his own mixed waist, but his knife-hand gets stuck in a radiator when he attempts to stab Andy, who pours molten plastic all over the evil doll. The half-melted Chucky suddenly attacks them again; in the struggle, Kyle shoves a high-pressure air hose into Chucky’s mouth, blowing off his head. Andy and Kyle exit the factory unsure of where to go, and walk off together.