On Christmas Eve, a baby at an orphanage crawls into Santa Claus's sack and is unwittingly taken back to the North Pole. Discovering the child at the workshop, the elves name him Buddy after his diaper's brand label and Papa Elf adopts him. Buddy is accepted by the elf community and grows up, thinking he is an elf. But being human sized, Buddy cannot keep up with the workload and is demoted to toy testing. Soon, Buddy overhears that he is a human and Papa Elf explains that Buddy was born to Walter Hobbs and Susan Wells who put him up for adoption before she died. 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. To Buddy's horror, Santa reveals that Walter is on the Naughty List due to his selfishness, but suggests Buddy could help redeem Walter.
Buddy travels to New York and finds Walter at work, but even after he mentions Susan Wells, Walter misinterprets him as a Christmas-gram messenger and has him ejected. Inspired by a security guard's sarcastic remark, Buddy heads to a local Gimbels department store, where he is mistaken for an employee. At the store's North Pole, he meets Jovie, an unenthusiastic employee with whom he is instantly smitten. Hearing that Santa will be at the store the following day, Buddy redecorates the store overnight. When realizing that the Gimbels Santa is not the real Santa, Buddy unmasks him and causes a brawl in the store resulting in Buddy being arrested.