Within events of the first game, Alice Liddell becomes insane, believing herself responsible for a fire that consumed her home and her family, escaping into a twisted version of Wonderland. While held at Rutledge Asylum for treatment, Alice was able to conquer her doubts, and eventually was released from the ward. In Alice: Madness Returns, a year has passed since Alice's release.[5][6] She now resides at an orphanage in Victorian London under the care of Doctor Angus Bumby, a psychiatrist that uses hypnotism to help his child patients forget their memories. Though she believes herself cured of her madness, hallucinations of Wonderland continue to appear.

During an errand, Alice is struck by an hallucination and believes herself to be in Wonderland again. Though initially idyllic, the peaceful land quickly becomes corrupted by the Infernal Train that rampages through it, leaving behind the Ruin, a force that attempts to stop Alice. Alice meets with the Cheshire Cat who affirms that it is some outside force, not Alice, that has caused this corruption, and urges her to seek out former friend and foe to discover the source of the Train. Throughout the rest of the game, the player witnesses periods where Alice briefly returns to reality between episodes occurring within Wonderland. In the real world, Alice learns from the family lawyer that her sister, Lizzie, was first to die in the fire, despite being the farthest from its source, and had been locked in her room.

Within the corrupted Wonderland, Alice attempts to learn more from Wonderland's various citizens, including the Mad Hatter, the Mock Turtle, the Walrus and the Carpenter, and the Caterpillar. She is ultimately told that the Queen of Hearts still lives despite her defeat at Alice's hands before, though in diminished capacity. At the Queen's castle, Alice discovers the Queen has taken on the appearance of Lizzie. The Queen reveals that an entity called the Doll Maker has taken over the Infernal Train and is corrupting Wonderland.

On return to London, Alice starts to recall her memories of the night of the fire, and realizes that Dr. Bumby was there. She comes to the conclusion that Dr. Bumby is attempting to erase the memories of the fire from her mind, and as he has done with other children, trying to leave her as a "blank toy" to be taken by child molesters for a price. Furious, Alice accosts both Dr. Bumby in the real world at the Moorgate station train station and Dr. Bumby's Wonderland counterpart, the Doll Maker, in her fantasy. Dr. Bumby admits to his crime, and even attests to setting Alice's home on fire after Lizzie refused his advances, removing any witnesses. He continues to point out that by wiping out her Wonderland, she too will forget the events of that night, while he will continue to be seen as an upper-class member of society. Alice fights and defeats the Doll Maker in Wonderland, giving her the strength in the real world to push Dr. Bumby into the path of an oncoming train. As Alice leaves the station, she finds herself in a hybrid vision of London mixed with Wonderland. Alice wanders into the somewhat unknown "Londerland" terrain as the Cheshire Cat monologues that Alice's memories, though damaged, are safe for the time being.