Born in Newport, Kentucky at the historic Southgate House, Thompson was the son of an Army lieutenant colonel and Union veteran. He therefore grew up on a succession of Army posts, and had decided on the military as a career by the age of sixteen. After a year at Indiana University (1877) he gained an appointment to the United States Military Academy, graduating in 1882.
His first duty station was in his birthplace of Newport, assigned to the 2nd Artillery as a second lieutenant. He then attended engineering and artillery schools, and was finally assigned to the Army's Ordnance Department in 1890, where he was to spend the rest of his military career. During this period he began his specialization in small arms.
With the beginning of the Spanish American War, Thompson was promoted to lieutenant colonel and sent to Tampa, Florida as Chief Ordnance Officer under the top commander for the Cuban campaign, General William R. Shafter. While the rest of the Army was plagued with logistical problems, Thompson on the contrary ran ordnance supply operations to Cuba in a highly efficient manner. Over 18,000 tons of munitions were transferred to the battlefield from his Tampa command without any accidents. Thompson was promoted to colonel, the youngest such in the Army at the time.
It was also this war which offered Thompson his first exposure to automatic weapons. At the request of Lt. John H. Parker, Thompson arranged for the informal formation of a Gatling gun unit, with fifteen weapons and a generous supply of ammunition, all shipped to Cuba on Thompson's sole authority. This unit would later play a significant role in the Battle of San Juan Hill.
After the war Thompson was appointed chief of the Small Arms Division for the Ordnance Department. While in this position he supervised development of the Springfield 1903 rifle and chaired the ordnance board that approved the M1911 pistol. For the latter he devised unusual tests involving firing the weapon at donated human cadavers and live cattle to assess ammunition effectiveness.
World War I began in Europe in 1914, and Thompson was sympathetic to the Allied cause. Since the U.S. did not immediately enter the war, and because he recognized a significant need for small arms in Europe (as well as an opportunity to make a substantial profit), Thompson retired from the Army in November of that year and took a job as Chief Engineer of the Remington Arms Company. While with the company he supervised the construction of the Eddystone Plant in Chester, Pennsylvania, at that time the largest small arms plant in the world. It manufactured Enfield rifles for British forces, and Moisin-Nagant rifles for Russia.
The introduction of trench warfare in the First World War changed tactics substantially, and by 1916 Thompson was experimenting again with automatic small arms, this time with an eye towards designing a weapon which troops could use to clear an enemy trench—what he called a "trench broom." Thompson studied several designs and was impressed with a delayed-blowback breech system designed by John Blish, a commander in the United States Navy. With Blish as a partner, Thompson obtained the necessary venture capital to form the Auto Ordnance Company, and set to work fine-tuning what would eventually become the Thompson submachine gun.
When the United States finally entered the war in 1917, Thompson returned to the Army and was promoted to the rank of brigadier general. He served as Director of Arsenals throughout the remainder of the war, in which capacity he supervised all small-arms production for the Army. For this service he was awarded the Distinguished Service Medal. He retired again after the war, in December 1918, and went back to work perfecting the "Tommy Gun."
Thompson eventually decided to use the same .45 caliber ammunition in the Thompson submachine gun that he had vetted for use in the M1911 while in the Army. The weapon was patented in 1920, but the major source for contracts had of course dried up with the armistice. Thompson therefore marketed the weapon to civilian law enforcement agencies, who bought it in respectable quantities. However, by 1928 low sales had led the company to financial crisis, and Thompson was replaced as head of the Auto Ordnance Company.
Thompson died at the age of 79 and is buried on the grounds of the United States Military Academy in West Point, New York. Ironically, shortly after his death the brink of U.S. entry into World War II prompted the Army to order the Thompson submachine gun in large quantities, and it was used extensively during that conflict.