A son of the former Elizabeth Jane Wharton and her first husband, Stephen Gaghan (died 1980), and a stepson of Tom Haag, Gaghan attended Kentucky Country Day School, a college preparatory school in Louisville. He is a grandson of Jerry Gaghan, a newspaper columnist and drama critic for Variety and the Philadelphia Daily News, whose career inspired Gaghan's own professional pursuits. As he wrote in a 2001 article in Newsweek, "I also wanted to be a writer, like my grandfather, who carried a card in his wallet that read, "If you find me, call my son [my father] at this number..."

In his final days of high school before graduation, Gaghan was expelled for driving a go-cart through the halls of the school. During the release of Traffic, a critic commented on one of the teen characters in the movie who is a drug addict and a straight-A student, calling it unrealistic, which Gaghan defended by stating that he had straight A's while he was addicted to drugs and alcohol. As Gaghan wrote in an article published in Newsweek in February 2001, "I wasn't much different from my peers, except where they could stop drinking after three or six or 10 drinks, I couldn't stop and wouldn't stop until I had progressed through marijuana, cocaine, heroin and, finally, crack and freebase--which seem for so many people to be the last stop on the elevator."

Gaghan has stated that he began dealing with his addictions in 1997. "Over one long, five-day weekend, I had three separate heroin dealers get arrested," he said. "My dealer, my backup dealer and my backup-backup dealer. I was left alone, and I just hit that place, that total incomprehensible demoralization. That was the end of it; up five days straight, locked in the bathroom, convinced there was nowhere else to go, I had to kill myself, I'm going to kill myself. I just couldn't take another minute of it."

He attended the University of Kentucky and was a member of Delta Tau Delta fraternity.

In addition to Traffic, Gaghan has also directed and written the screenplays for Syriana (2005) and Abandon (2002). Other writing credits include Havoc (2005), The Alamo (2004) and Rules of Engagement (2000), as well as a handful of episodes of various television series. Gaghan recently turned down the chance to adapt Dan Brown's novel, The Da Vinci Code.

In his television writing career, he won an Emmy Award for co-writing a NYPD Blue episode entitled Where's Swaldo, in 1997. In addition to NYPD Blue, he has also written for The Practice and New York Undercover.

As a filmmaker, Gaghan is generally regarded as one of the two precursors of the style known as hyperlink cinema, along with the Alejandro González Iñarritu/Guillermo Arriaga writer-director team of Amores Perros, 21 Grams and Babel. Most especially, Syriana's convoluted narrative, which mimics the confusion and lack of information of the characters yet manages to capture the complexity and feel of being in its particular milieu, is considered a prime example of the hyperlink film.

From November 15, 2006, Nintendo ran a series of television advertisements for the Wii directed by Gaghan as a part of a US$200 million ad campaign. The productions are Nintendo's first broad-based advertising strategy and include a two-minute video clip showing grandparents and parents enjoying the Wii console with their children. 80% of the advertisements target adults in an attempt to expand the market beyond Nintendo's traditional audience. The music in the ads is from the song "Kodo (Inside the Sun Remix)" by the Yoshida Brothers

His next project is a film adaptation of Malcolm Gladwell's book Blink: The Power of Thinking Without Thinking. The film is said to star Leonardo Di Caprio.

On 19 May 2007, at St. Thomas Church in New York City, Gaghan married Marian "Minnie" Mortimer (b. 1981), the only daughter of John Jay Mortimer and his wife, the former Senga (Mucci) Davis. The bride's mother is an editor at House Beautiful.

Minnie Gaghan is a great-granddaughter of Henry Morgan Tilford, who was a president of Standard Oil from 1893 to 1907, and also a descendant of the first Chief Justice of the United States, John Jay. Her maternal grandfather was Henry Mucci, an Italian-American U.S. Army officer who rescued the survivors of the Bataan Death March. Her paternal grandfather, Stanley Grafton Mortimer, was a stockbroker who became "one of the half dozen greatest amateurs in the American history" of racquetball.

Gaghan has a son, Gardner (b. 2000) and a daughter, Elizabeth (b.2001), from a prior relationship with Michael McCraine, an actress and model.