As the story begins, Alex, Marty, Gloria, and Melman try to escape Madagascar and return to New York using a hot air balloon they built, only to be thwarted by the now-nice lemur population who mistake them for the "red night goblin" that visits every year at this time, the 24th of what he calls "Julianuary", according to the king.
Immediately after that, the "red night goblin" appears and begins showering / pelting the island with coal. Evading the barrage, Alex manages to shoot it down, but the four friends discover that the "red night goblin" is, in fact, Santa Claus; what is worse, the crash has left him with amnesia, unaware of his responsibilities. Julien comments around this time that he has "another hat on," indicating the large bump on his head.
Alex, Marty, Melman, and Gloria huddle together and come up with a plan: deliver all the presents for Santa and then use the sleigh and reindeer to get them back to New York. Unfortunately, the leader of the reindeer says they only take orders from Santa, and it is revealed that they have a rivalry against the penguins.
The penguins accuse the reindeer of hijacking Santa and his workshop, which had originally been at the South Pole. Before the two species can fight, Private falls in love with Cupid, a female reindeer. Skipper slaps him out of his daze. The team is then forced to use the penguins, who use Santa's magic dust, to enable the otherwise flightless birds to take wing. They take off and leave Santa behind with the lemurs, who are presenting gifts for the king in celebration of Merry Julianuary. As Santa searches for a gift, he discovers his ability to make toys, much to the amazement of the lemurs. He soon crafts gifts for all of them to enjoy, much to Julien's anger since the focus is supposed to be on him.
Meanwhile, the animals make their first attempt at a delivery and manage to make a mess of everything – getting stuck in chimneys, breaking windows, getting lost. Realizing the full scope of the task at hand, they decide to instead drop the toys off at the post office and make their way back to New York. However, after crashing into an apartment and unintentionally bringing joy to a little girl, they reverse course and continue the deliveries.
Back on Madagascar, Julien is quietly going through his mound of gifts alone in the crashed plane, feeling depressed. Santa shows up to apologize for his earlier "behavior" and suggests that giving someone a gift might change the king's mood. After giving one to his friend, the dead co-pilot on the plane, Julien discovers that is indeed the solution. As a result, he hands out gifts to all the other lemurs.
As the night nears its end, Alex, Marty, Melman, and Gloria discover that they and the penguins only have enough magic dust to make one last trip, either back to their home in New York or back to Madagascar, where Santa remains stranded. Putting aside their personal wishes, they try to return to Madagascar, but unfortunately Skipper was wrong and they start falling: Rico first, then Kowalski, and Skipper. Apparently, Private had some magic dust left, but he couldn't hold the sled and all 7 animals alone. However, Cupid cheers him on and Private gains the courage to hold all seven animals, plus the sled, but it is sent crashing onto the beach and running over Santa by mistake. However, the crash also has the effect of restoring Santa's memory. After getting up, Santa thanks Alex and the others for making his deliveries for him.
Santa discovers one last bag meant for Liechtenstein and, to make the delivery in time, switches to a reserve tank of magic dust that the animals had overlooked. He flies away with his reindeer leading the charge before the animals can manage to ask for a ride to New York. With the holiday spirit filling them, the animals decide to make the best of the situation and create their own Christmas along with the lemurs on Madagascar.
However, Julien, wanting to get back on the naughty list, deliberately hits everyone with coconuts. Eventually, Julien hits Alex with another coconut, causing a large lump on the lion's head. When his friends ask if he is all right, he asks who Alex is, disappointing everyone. The special ends with Mort yelling to the viewers, "Merry Christmas and happy Julianuary, everybody!" and then suddenly getting chucked in the head with a coconut by Julien.