On Christmas Eve, an orphaned baby crawls into Santa Claus' sack at the sight of a teddy bear, and is unknowingly taken back to the North Pole from an orphanage. After the infant is discovered at the workshop, the elves name him Buddy after his diaper's brand label: Little Buddy Diapers, and Papa Elf adopts him. Buddy is accepted by the elf community and grows up thinking he is an elf. As an adult, Buddy overhears he is a human. Papa Elf explains to Buddy that he was born to Walter Hobbs and Susan Wells. Susan put him up for adoption prior to her death. Walter now works as a children's book publisher at the Empire State Building in New York City and is unaware of Buddy's existence. Santa reveals that Walter is on the Naughty List due to his selfishness, but suggests Buddy could help redeem him with some Christmas spirit.
Buddy travels to New York and finds Walter at work, but Walter mistakes him for a Christmas-gram messenger and has him ejected. Buddy is heartbroken, but brightens up as he wanders into a local Gimbels department store, where he meets Jovie, an unenthusiastic employee in the toy department, whom he is instantly smitten with. Hearing that Santa will be at the store the following day, Buddy redecorates the store overnight. However, upon realizing that the Gimbels Santa is just an employee in a costume, Buddy unmasks him and causes a brawl in the store that the manager breaks up.
Walter reluctantly bails Buddy out of the police station and takes him for a DNA test, confirming that Buddy is his biological son. Dr. Leonardo convinces Walter to take Buddy home to meet his stepmother Emily and half-brother Michael. Walter and Michael are unnerved by Buddy's strange behavior, but Emily insists that they take care of him until he "recovers". Michael warms up to Buddy after they defeat a gang of bullies in a snowball fight and encourages Buddy to ask Jovie out on a date. During the date, the two fall in love.
Meanwhile, Walter's publishing company is failing after their latest book flops. Walter's boss, Fulton Greenway, expects Walter to have a new book ready by Christmas Eve. Walter and his team secure a meeting with best-selling children's author Miles Finch, but Buddy interrupts the meeting and mistakes Finch, who has dwarfism, for an elf. Buddy unintentionally insults Finch before the latter attacks him and angrily leaves the meeting, upon which Walter loses his temper and harshly disowns Buddy. Heartbroken, Buddy writes an apology note on an Etch A Sketch and leaves Walter’s apartment.
Upon finding Finch's notebook full of ideas, Walter and his team scramble to create a book to pitch. As Walter prepares to pitch the book to Greenway, Michael arrives and informs Walter of Buddy's departure. Realizing his mistake, Walter quits his job and walks out with Michael to find Buddy. Meanwhile, Buddy sees Santa's sleigh crash in Central Park, attracting a large crowd. Santa explains that the sleigh’s engine is lost and cannot fly without it due to a shortage of Christmas spirit.
Buddy finds the engine and reunites with Walter and Michael. Walter apologizes to Buddy for his harsh words and accepts him as his son. After he takes them to meet Santa, Michael takes Santa's list and reads it in front of television news cameras gathered outside the park, proving that Santa is real. A group of Central Park Rangers sent to investigate (whom Santa recognizes from the Naughty List) chase the sleigh as Buddy tries to reattach the engine. Jovie leads the crowd (including a reluctant Walter) and those watching on television in singing "Santa Claus Is Coming to Town", raising enough Christmas spirit to fully power the sleigh without the engine.
By the following Christmas, Buddy and Walter establish their own publishing company, with their first bestseller being a children's book based on Buddy's exploits. Buddy also marries Jovie and brings their newborn daughter Susie to visit Papa Elf.
