The movie starts off when Matilda is a baby. She is very smart, and by age three has read everything in the house and wants nothing more than a book. So she starts going to the library and increasing her brainpower. Meanwhile at home, her parents are horrible and don't pay her any attention. Every time her father does something bad, she plays a trick on him (supergluing his hat to his head, putting bleach in his hair tonic). Her father is also a crooked used car salesman, and is being watched by two cops who pose as speedboat salesmen and videotape the house from across the street.
Things start to look better for Matilda after her father meets Agatha Trunchbull, a headmistress of a local school, and he enrolls Matilda in school there. But the Trunchbull is a horrible woman (and an ex-Olympian, famous for shotput, javelin, and hammer throw), who disciplines her students by throwing them out of windows, over the fence, making them eat huge chocolate cakes, and putting them in the chokey. All the students fear the Trunchbull.
As horrible as the Trunchbull is, that's how wonderful Miss Honey, Matilda's classroom teacher, is. All the kids adore her. She recognizes right away that Matilda is a very smart child, and, after an unsuccessful meeting with Matilda's parents, gives Matilda work from the upper grades to do. But Miss Honey has a terrible secret--her mother died when she was a baby, and her father "killed himself" when she was five, but not before her father's stepsister had come to live with them, and Miss Honey was brought up by a horrible horrible woman--Miss Trunchbull.
One day when the Trunchbull is teaching Matilda's class, her friend Lavender puts a newt in the Trunchbull's waterglass. When the Trunchbull is particularily mean to Matilda, she makes the glass tip over with her "special powers" in her eyes. Miss Honey knows Matilda is very sweet but also very lonely, and takes her home for tea when Matilda tries to explain her powers. They form a very special bond, and Miss Honey tells Matilda about growing up with the Trunchbull, and how she had to escape and leave her treasures behind in the house. Matilda decides they need to go and rescue her doll, but the Trunchbull comes home and nearly catches them. Miss Honey makes Matilda promise never to go back in there, but she uses her powers and, from the roof, rescues Miss Honey's doll and creates some superstitious havoc for the Trunchbull at the same time.
Meanwhile, the policemen are ready to make a move on Matilda's dad. Matilda buys her father some time by stealing their video tape after making their car roll down the street.
When the Trunchbull realizes she's been tricked, due to the hair ribbon left outside her house, she's ready to put Matilda away in the chokey for life. But Matilda hatches another plan, and convinces the Trunchbull that Miss Honey's father, Magnus, is threatening her from the grave. The Trunchbull gets scared, runs away (covered in food from the contents of all the students' lunches), and everyone is happy.
Miss Honey moves back into her childhood home, and becomes the new headmistress of the school. After Matilda's parents and brother escape the police by moving to Guam, Miss Honey adopts Matilda and all is well in the world.