Gaddis was born in New York City to William Thomas Gaddis, who worked "on Wall Street and in politics," and Edith Gaddis, an executive for the New York Steam Corporation. When he was 3, his parents separated and Gaddis was subsequently raised by his mother in Massapequa, Long Island. At age 5 he was sent to Merricourt Boarding School in Berlin, Connecticut. He continued in private school until the eighth grade, after which he returned to Long Island to receive his diploma at Farmingdale High School in 1941. He entered Harvard in 1941 and famously wrote for the Harvard Lampoon (where he eventually served as President), but was asked to leave in 1944, supposedly because of a drunken brawl, though the circumstances are unclear. He worked as a fact checker for The New Yorker for two years, then spent five years traveling in Central America, the Caribbean, North Africa, and Paris, returning to the United States in 1951.

His first novel, The Recognitions, appeared in 1955. A lengthy, complex, and allusive work, it had to wait to find its audience. Newspaper reviewers considered it overly intellectual, overwritten, and perhaps on the principle of ("all that is unknown appears obscene"), filthy. (The book was defended by Jack Green in a series of broadsheets blasting the critics; the series was collected later under the title Fire the Bastards!) Shortly after the publication of The Recognitions, Gaddis married his first wife, Patricia Black, who would give birth to two children: Sarah (who has written a novel, Swallow Hard, inspired by her relationship with her father) and Matthew.

Gaddis then turned to public relations work and the making of documentary films to support himself and his family. In this role he worked for Pfizer, Eastman Kodak, IBM, and the United States Army, among others. He also received a National Institute of Arts and Letters grant, a Rockefeller grant, and two National Endowment for the Arts grants, all of which helped him write his second novel. In 1975 he published J R, a work even more difficult than The Recognitions, told almost entirely in dialogue, where it is sometimes difficult to determine which character is speaking. Its eponymous protagonist, an 11-year-old, learns enough about the stock market from a class field trip to build a financial empire of his own. Critical opinion had caught up with him, and the book won the National Book Award for Fiction. His marriage to his second wife, Judith Thompson, dissolved shortly after J R was published. By the late 1970s, Gaddis had entered into a relationship with Muriel Oxenberg Murphy, and they lived together until the mid-1990s.

Carpenter's Gothic (1985) offered a shorter and more accessible picture of Gaddis's sardonic worldview. Instead of struggling against misanthropy (as in The Recognitions) or reluctantly giving ground to it (as in JR), Carpenter's Gothic wallows in it. The continual litigation that was a theme in that book becomes the central theme and plot device in A Frolic of His Own (1994)...which earned him his second National Book Award and was a finalist for the National Book Critics Circle Award for Fiction...where it seems that everyone is suing someone. There is even a Japanese car called the Sosumi. (Gaddis has never been afraid of the pun. There is a character in The Recognitions named Recktall Brown.)

Gaddis died at home in East Hampton, New York, of prostate cancer on December 16, 1998, but not before creating his final work, Agap? Agape (the first word of the title is the Greek agap?, meaning divine, unconditional love), which was published in 2002, a novella in the form of the last words of a character similar but not identical to his creator. The Rush for Second Place, published at the same time, collected most of Gaddis's previously published nonfiction.

After years of critical neglect, Gaddis is now often acknowledged as being one of the greatest of American post-war novelists. A critic who early on appreciated his work and recognized its value is Steven Moore: in 1982 he published A Reader's Guide to William Gaddis's "The Recognitions" and in 1989 a monograph on Gaddis in the Twayne series. Gaddis's influence is vast (although frequently subterranean): for example, postmodern authors such as Don DeLillo and Thomas Pynchon seem to have been influenced by Gaddis (indeed, upon publication of V., Pynchon was actually speculated to have been a pen name for Gaddis due to the similarity of styles and the dearth of information about the two authors; the Wanda Tinasky letters also claimed that Gaddis, Pynchon, and Jack Green were the same person), as well as authors such as Joseph McElroy, William Gass, David Markson, Jonathan Franzen, and David Foster Wallace, who have all stated their admiration for Gaddis in general and The Recognitions in particular.

His life and work are the subject of a comprehensive website, The Gaddis Annotations, which has been noted in at least one academic journal as a superior example of scholarship using new media resources. Much of the annotations on the site are the work of Steven Moore, the critic who recognized Gaddis's genius early. Gaddis's papers are collected at Washington University in St. Louis.

Gaddis has received the following awards and honorary positions:

• The MacArthur Foundation’s "genius award" (1982),
• Election to the American Academy and Institute of Arts and Letters (1989),
• The Lannan Literary Award for Lifetime Achievement (1993).