According to a user on the official SEGA forums, former Sonic 4 Brand Manager Ken Balough confirmed that Sonic 4 had a third episode planned, but it was cancelled. He has in the past hinted that a third episode was planned but this is the first time anyone associated with the project has come out and said that the series was to be a trilogy and that the third part was scrapped.

So… Sonic 4 had a third episode planned, but it was cancelled. Is anyone surprised?

No, it isn’t really that surprising since evidence was uncovered around two days after the game came out to suggest a third episode was planned when files game showed evidence of a scrapped cutscene.

However, for anyone who had hoped it would come out, Ken had this to say…

Looks like the project is well and truly dead.

Christian Whitehead – aka Taxman, who was partly responsible for the Sonic 1, 2 and CD remasters – has commented on Sonic 4: Episode 3 and shed more light on it.

I’ve always assumed Sonic 4 Episode 3 fizzled out as things evolved with SOA, Sega Networks & F2P etc. I guess it’s been long enough that it’s not relevant any more, but I was briefly asked if I would be interested in collaborating with Sega Studios Australia (Who did the Castle of Illusion remake) as a potential dev team to work on the third one. Sadly though, SSA were shut down, and Stealth and I worked on the Sonic 1 & 2 remasters in late 2012-2013. Of course, you never know, Sonic Team could one day decide Ep3 should happen, but Ken pretty much confirms my personal thoughts.

So Taxman was asked to work on it at one point alongside the now closed Sega Studios Australia. Most interesting part about this is that it sounds like Sega dumped DIMPS when it came to episode 3.

Source: Sonic Retro