He was born in Blackpool, England of Irish-Scottish Catholic extraction, but grew up in Withington, Manchester, and was educated at St. Joseph's College, Blackpool. (Many Mancunians were born outside the city during World War 2 as pregnant mothers were evacuated to towns like Blackpool).

He sold peanuts at Manchester United football matches (although it is reported that he supports Manchester City) and first discovered acting in the Stretford Youth Theatre. He moved to the United States as a young man when he intended to visit his sister, a war bride.

He studied at Quincy University, Illinois, before joining the United States Army to speed up the citizenship process and to become a U.S. citizen.

Mahoney later lost all traces of his original accent, but he did resurrect it once, and only once, on Frasier, while mocking Daphne Moon (played by English actress Jane Leeves).

He lived in Macomb, Illinois and taught English at Western Illinois University in the early 1970s, before finally settling in Oak Park, Illinois. He served as editor for a medical journal publisher through much of the 1970's.

Disillusioned with his career, Mahoney later said he realized that as he was approaching middle age, he was coming to terms with his future which made him very depressed. Ready for a change, Mahoney took acting classes at St. Nicholas Theater that inspired him to quit his day job and pursue acting full time, and after a stage production in 1977, fellow actor John Malkovich encouraged him to join Steppenwolf Theatre. He did and was very successful.

He made his film debut in 1980, and has played supporting roles in such films as Suspect and Moonstruck (both 1987), Frantic (1988), Say Anything... (1989), Barton Fink (1991), In the Line of Fire (1993), The Hudsucker Proxy (1994), The American President (1995), and Primal Fear (1996).

He also provided the voices for several characters in the animated film Antz (1998), as well as Whitmore in Atlantis: The Lost Empire. Although he has often played "good guy" roles, Mahoney has occasionally gone into "bad guy" territory, evident by his work in Reality Bites as a diva talk show host who torments Winona Ryder's character.

He appeared in Frasier from its inception in 1993 until the final episode in 2004, and received numerous Emmy and Golden Globe award nominations for this role.

Coincidentally, Mahoney also appeared in an episode of Cheers as an inept jingle writer, including a brief conversation with Frasier Crane (Kelsey Grammer), whose father he would later play.

He has since returned to his home in Chicago to work with the Steppenwolf Theatre again. Mahoney cites theater as his first passion.