At the Tromaville Video Store, a band of Apocalypse Inc. goons decides to hold everyone hostage and demand that the people inside the store begin watching their films rather than the likes of MGM, Warner Bros., and even Troma movies. After killing one video store customer, the goons shoot up the place. However, Melvin Junko, also known as the Toxic Avenger arrives. Posing at first as a life-size cardboard cutout of himself, Toxie is able to kill all the goons in various gruesome fashions including disembowelment, smashing one goon's face into a video eraser, and sticking another one's arm through a VCR, destroying it in the process before decapitating him. Declaring he is back, Melvin reveals the flashback story of how he had worked for the forces of evil.
It all began with his saving Tromaville from the Dark Rider. Things have become peaceful again in Tromaville, putting Melvin into depression as he enjoying fighting crime but now cannot even do that. Failing at normal jobs from being an auto mechanic and babysitter, Melvin is depressed. When he learns Claire, his blind girlfriend may be able to see again thanks to a new groundbreaking surgery, they are elated. That is until Melvin tells Claire that it will cost $347,000 to get the surgery. However, there is a job opportunity and it would involve Melvin serving as a spokesman for none other than Apocalypse Inc., the New York-based chemical company he defeated before. Melvin will be paid enough for Claire's surgery and he accepts, signing the contract in his own blood. Claire successfully has her surgery and for the first time, she sees Melvin and falls even more in love with him.
However, as Apocalypse Inc. comes in to heavily promote their chemicals, the people of Tromaville are shocked to see that their hero, The Toxic Avenger, is agreeing with Apocalypse. Toxie's ego has inflated to a point where he has become a yuppie. Claire, now with her sight, sees what has transpired and unsuccessfully confronts Melvin. When Melvin sees a group of kids knocking down a poster of him and kicking it, it causes Melvin to finally realize what has happened. Melvin, through thinking about the day he signed the contract, remembers a saying at church, which finally makes him see the light of day. Deciding to once again clean up Tromaville, he earns the trust of the people of Tromaville once again and the flashback is over, bringing the story back to the video store. However, he now faces against the Chairman, who finally reveals his true identity. The Chairman is actually Satan himself, a green-skinned demon who challenges Melvin to a game involving his favorite video game, "The Five Levels of Doom".
The first level, Earth, involves Melvin getting sucked into the ground. However, when he is able to get his head out of the ground, Malfaire offers an Apocalypse thug to decapitate Melvin with a mower but it proves to be unsuccessful. The second level, Fire, has both Melvin and the Devil set on fire. Melvin is saved by some Tromaville residents, who douse him with water. When the Devil is still on fire and laughing hysterically, Melvin resorts to urinating on the Devil, extinguishing the flames. The third level, Wind, has the Devil kidnap the kids of Tromaville and sends them to the nearest mountain by bus and unleashing strong winds that risk putting the bus over the mountain. Melvin arrives at the cliff and has the kids escape via the back door. Malfaire, in an attempt to shoot down Melvin and the kids, is crushed by the bus when it falls down the cliff. The fourth level, Water, has Melvin on the hood of the repaired bus driven by the Devil and put into a massive puddle in an attempt to drown him. However, Melvin, using a Sumo trick he learned in Japan, is able to escape.
However, the Devil unleashes the final level, in which he transforms the Toxic Avenger back into Little Melvin, who once again becomes the victim of bullying, now by Apocalypse. When Claire attempts to intervene, she is once again rendered blind. While Melvin is getting picked on, Claire returns home and finds the contract. She manages to find an escape clause that will allow termination by an act of God. An angel, disguised as a messenger, arrives and gives Melvin a scroll. It begins to rain and Melvin is transformed back into the Toxic Avenger and Claire is able to once again see. Having had enough, Melvin defeats the Demon, ripping his skin off to expose rats and bugs all over his carcass. He decapitates the Devil and throws his head, which is sent to Tokyo, where the news reporter from the previous film demonstrates a new hair growth formula to a customer. When the Devil's head lands on the customer, the news reporter is elated and begins to spray more while the customer screams in shock.
Having defeated Apocalypse Inc. once and for all, Melvin and Claire celebrate by getting married and are now "monster and wife".
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