Eleven years after the first film, Dr. Arthur Neuman (Ben Stein) is giving a tour of the hall of Norse mythology in Edge City Museum. When Dr. Neuman reaches the part concerning Loki's mask, a man in black becomes increasingly anxious. Dr. Neuman mentions that Loki created the mask and unleashed it on Earth, and that those who wear the mask would have the powers of Loki. When Dr. Neuman mentions that Odin punished Loki with imprisonment, the stranger becomes very angry and transforms, revealing himself to be Loki (Alan Cumming). The tourists panic and flee, but Dr. Neuman stays to argue with the angry god. Loki takes the mask, but realizes it is a fake. In anger, he removes Dr. Neuman's still talking face from his body and puts it on the mask stand, before getting rid of the guards and storming out of the museum in a whirlwind of rage.
Meanwhile, the real mask (thrown in the river by Tina Carlyle at the end of the previous film) makes its way to a town called Fringe City, not far from Edge City, and is found by a dog named Otis - who belongs to Tim Avery (Jamie Kennedy), an aspiring cartoonist at an animation company, is feeling reluctant to become a father. He has a beautiful wife, Tonya (Traylor Howard), and a best friend, Jorge (Kal Penn). On a tropical island, Loki is relaxing until Odin (Bob Hoskins) confronts him and orders his son to find the mask. Loki asks Odin to help him, but Odin tells Loki that this is his mess and he has to clean it up. Later that night, Tim puts on the mask for a Halloween party, transforming into a party animal similar to the mask character from the first film. Tim notices Jorge's crush, Sylvia, standing alone in the back, eagerly confronts her and has her stripped out of her costume and into a skimpy red suit. Sylvia falls into Jorge's arms, which pleases them both. When the company party turns out to be a bore, Tim uses his mask powers to perform a remix of "Can't Take My Eyes Off You", making the party a success, and giving Tim's boss the idea for a new cartoon, resulting in his promotion the next day.
Tim returns to his house and, while still wearing the mask, conceives a baby. The baby, when he is born, has the same powers as Loki. Meanwhile, Loki is trying to find the child born from the mask, as his father Odin, possessing a store clerk, tells him if he finds the child, he will find the mask. Later, Tonya goes on a business trip, leaving Tim with the baby. Tim, who has been promoted at work, desperately tries to work on his cartoon at home, but is continuously disrupted by baby Alvey. In order to get some peace and quiet, Tim lets Alvey watch TV, which shows Michigan J. Frog. Alvey devilishly obtains the idea to mess with his father's head by using his mask powers. Meanwhile, Otis the dog, who has been feeling neglected by Tim because of Alvey, dons the mask by accident and becomes a crazed animal version of himself, who wishes to get rid of the baby, but all his attempts are overturned by Alvey. Tim starts to notice his son and dog's wild cartoonish behavior when Alvey starts harassing him.
Eventually, Loki finds the mask-born baby, and confronts Tim for the mask back, but is thwarted again and again by Alvey who uses his powers to protect his father. Eventually, Odin becomes fed up with Loki's destructive approach and strips his son of his powers. A seemingly-deranged Tim is later fired after failing to impress his boss during a pitch, but is able to reconcile and bond with Alvey. Loki, still determined to please his father, manages to complete a summoning ritual and appeal to Odin to restore his powers. Odin agrees, but only for a limited time, stating this as "your final chance". Loki then kidnaps Alvey to exchange for the mask, but decides to keep him despite the exchange, forcing Tim to don the mask again to fight Loki. The subsequent confrontation is relatively evenly matched due to Loki and Tim-in-the-Mask possessing equal powers, prompting Loki to halt the fight, and suggest that they let Alvey decide who he wants to live with. Although Loki tries to lure Alvey to him with toys and promises of fun, Tim wins when he removes the mask and asks Alvey to come back to him using the human connection he has forged with his son. Saddened and enraged, Loki tries to kill Tim, but his time runs out and Odin appears in person. Odin disowns Loki, calling him a failure, and begins to banish Loki, but Tim confronts the powerful Norse god and tells him that the most important thing in life is a relationship with your family, and Odin accepts Loki as a son, accepting the mask from Tim as well. Tim's cartoon, based on his own experiences of a boy and a dog competing for the father's attention (with Jorge playing the father via motion capture performance), is a hit, and Tonya reveals that she is pregnant again before the film closes.
Visiting Tooth's world, Jack learns that baby teeth contain the memories and innocence of the children who lost them; Jack's teeth are included and he informs her that he has forgotten his true identity. However, Pitch raids Tooth's home in order to kidnap all of her subordinate tooth fairies, except Baby Tooth whom Jack managed to save, so that the children's teeth can't be collected. If the teeth aren't collected the children will stop believing in her. In order to complete the scheme, he also steals all the teeth thus preventing Tooth from sharing Jack's memories with him. In order to thwart the evil plan the group decides to travel the world collecting the lost teeth. During their journey they come across a young boy named Jamie, who is awakened during a quarrel between North and Bunnymund. Since he believes in them all he can see them except for Jack. Pitch's nightmares attack in full force, provoking Sandy into action as the Guardian of Dreams. Jack aids him, but fails as Sandy is overwhelmed and seemingly destroyed by Pitch.
As Easter approaches, the dejected Guardians gather in Bunnymund's home. With the unexpected aid of Jamie's little sister, Sophie, they begin the process of painting eggs for the coming morning. After Jack takes Sophie home, he is lured to Pitch's lair by a voice. While there, Pitch taunts him with his memories and fears of not being believed in. This distracted Jack long enough for the nightmares to destroy all the Easter eggs, ruining Easter and causing children to stop believing in Bunnymund. After losing his trust in the disappointed Guardians, Jack isolates himself in Antarctica, where Pitch tries to convince Jack to join his side. When Jack refuses, Pitch threatens to kill Baby Tooth, unless Jack gives him his staff. Jack agrees, but Pitch breaks Jack's staff and makes him fall into a chasm. Jack unlocks his memories and he remembers that he was a mortal human boy who fell into a frozen pond while saving his younger sister from falling through. This memory inspires Jack and he fixes his staff and returns to Pitch's lair to rescue the kidnapped baby fairies.
Due to Pitch's powers, all the world's children's beliefs in the Guardians fade, except Jamie's. When Jack finds even Jamie's faith in them is wavering, Jack causes it to snow in his room and makes him realize that Jack Frost exists. Jack is finally seen and heard after centuries and while the weakened Guardians face Pitch in battle, Jack and Jamie gather Jamie's friends, whose renewed belief bolsters their fight against Pitch as well. Pitch tries to terrify the children with his nightmares, but their dreams prove even stronger, resulting in Sandy's resurrection. Defeated and no longer feared, Pitch tries to retreat, but his own nightmares turn against him due to his own fear and drag him under the desolate bed into his own world. Afterward, Jamie and his friends bid goodbye to the Guardians as Jack accepts his place among them as the Guardian of Fun.