The square artifacts in the dithered image are caused by the distribution not doing second passes over the pixels already with error distributed, this is a byproduct of the "custom" approach the OP uses, they've traded off (greater) individual colour error for general picture cohesion.

Me, I adjusted Atkinson a few years ago as I prefer the "blown out" effect: https://github.com/KodeMunkie/imagetozxspec/blob/master/src/...

A similar custom approach to prevent second pass diffusion is in the code too; it is slightly different implementation - processes the image in 8x8 pixel "attribute" blocks, where the error does not go out of these bounds. The same artifacts occur there too but are more distinct as a consequence. https://github.com/KodeMunkie/imagetozxspec/blob/3d41a99aa04...

Nb. 8x8 is not arbitrary, the ZX Spectrum computer this is used for only allowed 2 colours in every 8x8 block so this seeing the artifact on a real machine is less important as the whole image potentially had 8x8 artifacts anyway.