In 1975, after serving 5 years of a 30-year prison sentence, Carlito Brigante is freed on a legal technicality exploited by his close friend and lawyer, Dave Kleinfeld. Carlito vows to be through with his criminal activities but is persuaded to accompany his young cousin Guajiro to a drug deal held at a bar. Guajiro is betrayed and killed by his suppliers and Carlito is forced to shoot his way out. Later, Carlito takes Guajiro's $30,000 from the botched deal and uses it to buy into a nightclub owned by a gambling addict named Saso with the intention of saving $75,000 to retire to the Caribbean.
The story begins in the 1960s with three inmates in a New York (state) prison — Earl (Van Peebles), Rocco (Kelly), and Carlito (Hernandez) — controlling their criminal empire within their cell. Upon their release, they all look to control the drug trade in Harlem, which is currently in a power dispute between the Italian Bottolota crime family and black gangsters led by Hollywood Nicky (Combs). Rocco takes them to Artie Bottolota (Young) who at first is reluctant to work with blacks and Puerto Ricos, but who eventually cuts a deal with them in heroin distribution. The friends also meet Artie's son, Artie Jr. Soon, Earl's troubled younger brother Reggie joins them. It does not take long for Reggie to cause trouble; eventually endangering both himself and Carlito's deal with the Bottolotas.