On Christmas Eve, a baby boy crawls into Santa Claus's sack at an orphanage and is unwittingly transported back to the North Pole. When discovered at the workshop, the elves name him "Buddy" because he is wearing "Little Buddy Diapers", and he is adopted by Papa Elf.
Buddy grows up at the North Pole believing he is an elf, but due to his human size is unable to keep up with the other elves and demoted to the demeaning job of toy testing. When Buddy overhears that he is a human, Papa Elf explains that Buddy was born to Walter Hobbs and Susan Wells, and given up for adoption. Susan subsequently died and Walter, who now works for a children's book publisher at the Empire State Building in New York City, is unaware of Buddy's existence. Santa reveals, to Buddy's horror, that Walter is on the naughty list due to his selfishness, but suggests Buddy could help redeem him.
Buddy travels to New York where he has trouble adjusting to the customs of the cynical human world. Buddy finds his father at work, but Walter is incredulous and has security remove him. Taking a security guard's sarcastic suggestion literally, Buddy visits the Gimbels department store where the manager mistakes him for an employee. At the store's Santa Land, he meets Jovie, an unenthusiastic employee to whom he is instantly attracted. After hearing that Santa will be at the store the following day, Buddy spends the night decorating Santa Land. When Buddy realizes that the Gimbels Santa is not the real Santa, he confronts him and yanks the beard off his costume, resulting in a fight that lands Buddy in jail. Walter reluctantly bails him out and takes him to a doctor for a DNA test, which confirms that Buddy is Walter's son. The doctor convinces Walter to take Buddy home to meet his step mother Emily and twelve-year-old half brother Michael. Walter and Michael are put off by Buddy's odd behavior, but Emily insists that they care for him until he "recovers".
Michael becomes fond of Buddy after Buddy defeats a gang of bullies in a snowball fight and Michael encourages Buddy to ask Jovie on a date. During the date, the two fall for each other. Walter's boss, citing the failure of the company's most recent book, expects a new book by Christmas Eve, so Walter and his team hire best-selling children's author Miles Finch. Buddy interrupts a meeting between Walter's team and Finch to tell Walter of his newfound love and mistakes Finch, who has dwarfism, for an elf. Buddy pesters Finch into losing his temper and walking out on Walter. Angry over the setback, Walter harshly disowns Buddy. Buddy leaves a note for Emily and Michael, and wanders the streets, lamenting that he does not fit in anywhere.
On Christmas Eve, after finding Finch's notebook full of ideas, Walter and his team scramble to create a book to pitch. Walter's boss is prepared to hear the pitch when Michael arrives and informs Walter that Buddy is gone. Realizing he was wrong, and unable to reschedule, Walter resigns and leaves with Michael to find Buddy.
Santa's sleigh crashes in Central Park, attracting a large crowd. Buddy finds Santa, who explains that the sleigh has lost its engine and cannot fly without it, due to a shortage of Christmas spirit. Buddy finds the engine and is reunited with Walter and Michael. Walter apologizes to Buddy and accepts him as his son; Buddy then 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. The Central Park Rangers, whom Santa had placed on the naughty list, chase the sleigh as Buddy tries to reattach the engine. Jovie leads the crowd in singing "Santa Claus Is Coming to Town," helping raise enough Christmas spirit to fully power the sleigh.
By next Christmas, Walter has started his own publishing company with a best-selling book about Buddy's adventures. Buddy and Jovie, now married, bring their newborn daughter Susie to visit Papa Elf.
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