Capshaw was born Kathleen Sue Nail in Fort Worth, Texas, the daughter of Beverley Sue (née Simon), a travel agent and beautician, and Edwin Leon Nail, an airline employee. She moved to St. Louis, Missouri at the age of five, and graduated from Hazelwood Senior High, now called Hazelwood Central High School in 1972. Capshaw earned a degree in education from the University of Missouri, where she was a member of Alpha Delta Pi. She taught Special Education at Southern Boone County High School in Ashland, Missouri and Rock Bridge High School in Columbia, Missouri. She took the surname Capshaw upon her marriage to Robert Capshaw in January 1976; they had one child, actress Jessica Capshaw, and eventually divorced in 1980.

Capshaw moved to New York to pursue her dream of acting, landing her first role on the soap opera Love of Life. She met film director Steven Spielberg upon winning the female lead (from a pool of 120 actresses) for the Raiders of the Lost Ark prequel, Indiana Jones and the Temple of Doom. She appeared in the Showtime Cable Network miniseries A Girl Thing with Elle Macphersonas her same-sex lover.

Capshaw, originally an Episcopalian, converted to Judaism before marrying director Steven Spielberg on October 12, 1991.

Capshaw is parodied in the Family Guy film Stewie Griffin: The Untold Story, for her character in an Indiana Jones film. A character in the video game Monkey Island 2: LeChuck's Revenge, Kate Capsize, is named after Kate Capshaw. Steven Spielberg is a friend of George Lucas whose film company, LucasFilm, founded LucasArts, the game's creator.