Thirty years before the events of the film unfold, a baby accidentally finds his way into Santa's sack at an orphanage. Unbeknownst to Santa, he takes the baby back to the North Pole, where Papa Elf is tasked with raising him. This baby, named Buddy, grows up without realizing he is actually human until his enormous size and lack of toy-making skills prompt Papa Elf to reveal the truth. The old elf informs Buddy that he was born to Walter Hobbs and Susan Wells and put up for adoption. Walter, unaware of Buddy's existence, is now living in New York and working at a children's book company. Learning of his father's existence—and that he is on Santa's naughty list—Buddy resolves to journey to New York to find him.
Upon arriving in the bustling city, Buddy's naiveté comes to the forefront; he awkwardly crosses streets at the wrong moments, chews discarded gum he finds on the sidewalk, and takes a coffee shop's proclamation of the "world's best cup of coffee" at face value. Eventually, Buddy tracks down his father in the Empire State Building, but his incredulous father, Walter Hobbs (Edward Asner), has him thrown out. After a security guard sarcastically tells Buddy to "get back to Gimbel's," he returns to find himself mistaken for an employee and meets the beautiful yet indifferent Jovie. The following morning, Buddy is shocked to discover the Santa at Gimbel's isn't the real one, leading to a comical altercation where he is arrested. Walter, albeit reluctantly, bails Buddy out and takes him to a pediatrician for DNA testing. Once it's confirmed that Buddy is Walter's son, he brings Buddy home to meet his wife, Emily, and their son, Michael.
Although Walter is visibly annoyed by Buddy's innocent antics—such as drenching his spaghetti in maple syrup and failing to comprehend Walter's lack of interest in childlike play—Emily insists that they care for Buddy until he "recovers." Buddy quickly befriends Michael after bravely defending him in a snowball fight against bullies, and this encourages Buddy to ask Jovie out. Walter unwittingly uses Buddy's innocence during a workday but becomes frustrated when Buddy drinks whiskey, mistakenly thinking it’s syrup, leading to a wild party in the mailroom. Buddy enjoys an enchanting date with Jovie, while Walter struggles to keep his business afloat by partnering with the temperamental best-selling writer Miles Finch. Buddy inaccurately believes that Finch is also an elf, which leads to an explosive confrontation, causing Finch to leave and Walter to yell at Buddy to "get the Hell out of my life." Feeling hurt, Buddy wanders through New York on Christmas Eve until he witnesses Santa's sleigh crash in Central Park.
He finds Santa, who informs him that the sleigh's engine has been lost along with the last bit of Christmas spirit powering it. Santa persuades Buddy to assist in fixing the sleigh. Back at Walter's company, Michael rushes in during a board meeting to plead with his father, who finally prioritizes family over work. Together, they find Buddy in Central Park while he works on the sleigh's engine. Buddy informs them that the success of the sleigh relies on people's belief in Santa, which is illustrated when Michael boldly steals Santa’s list and reads it live on television, igniting widespread belief in the city. Chased by Central Park Rangers, Buddy struggles to reattach the engine. Meanwhile, Jovie recalls Buddy's words: > "The best way to spread Christmas cheer is singing loud for all to hear,” and gathers the crowd to sing "Santa Claus is Comin' to Town," invoking the Christmas spirit needed to lift the sleigh into the sky. Ultimately, even Walter joins in the song.
In the concluding recap, Papa Elf shares that Walter has since launched his own publishing company, with Buddy’s adventures serving as the inaugural book. Furthermore, it is revealed that Buddy and Jovie have married and had a daughter named Susie, whom they take to the North Pole for visits.
