Sarah Polley, the youngest of five children, was born in Toronto, Ontario, the daughter of Diane, an actress and casting director, and Michael Polley, a British-born actor and insurance agent. Polley's mother died of cancer just after Polley's 11th birthday. Polley attended Subway Academy II then Earl Haig Secondary School, but dropped out before graduating.

Her first cinematic appearance was at the age of four, as Molly in the Disney film One Magic Christmas. At age eight, she was cast in the title role in the television series Ramona, based on Beverly Cleary's books. Though the series lasted but one season, Polley burst into the public eye the following year as Sara Stanley on the popular CBC television series Road to Avonlea, produced by Kevin Sullivan. The series made her famous and financially independent, and she was hailed as "Canada's Sweetheart" by the popular press.

The show was picked up by the Disney Channel for distribution in the U.S. At the age of 12 (around 1991) Polley attended an awards ceremony while wearing a peace sign to protest the first Gulf War. Disney executives asked her to remove it and she refused. This soured her relationship with Disney and she left Road to Avonlea in 1994. The show itself was cancelled in 1996 (to which she publicly claimed indifference), although she did return as Sara Stanley for an episode in 1995 and for the final episode in 1996.

Polley appeared as Lily on the CBC television series, Straight Up. It ran from 1996–1998 and she won the Gemini Award for Best Performance in a Children's or Youth Program or Series for her role. Polley's subsequent role as Nicole Burnell in the 1997 film The Sweet Hereafter, brought her considerable attention in the United States; she was a fan favourite at the Sundance Film Festival.

She was cast in the role of Penny Lane in the big-budget 2000 film Almost Famous, but dropped out of the project to return to Canada for the low-budget The Law of Enclosures. Her role in the 2003 film My Life Without Me, garnered the Genie Award for Best Performance by an Actress in a Leading Role in 2004. In the same year, she starred in a lead role in the stylish and successful remake of Dawn of the Dead, which was a departure from her other indie roles. In 2005 she starred in The Secret Life of Words, opposite Tim Robbins and Julie Christie She was nominated as Best European Actress by the European Film Academy for her role as Hanna.

She made her feature-length film directing debut with Away From Her, based on the Alice Munro short story The Bear Came Over the Mountain. The movie, starring Julie Christie debuted at the Toronto International Film Festival on September 11, 2006 and it earned Polley a 2008 Academy Award nomination for her adapted screenplay and winning the Genie Award for Best Achievement in Direction (the first woman to do so).

Polley takes pride in her work and enjoys both acting and directing but is not keen on combining the two. "I like the feeling of keeping them separate. I find that really gratifying. I can't imagine combining those. For me, I love the feeling of using different parts of my brain separately."