Wallace was born in Brookville, Indiana, to David Wallace and Esther French Test Wallace. His father was a graduate of the United States Military Academy[1] and served as lieutenant governor and Indiana Governor; his stepmother, Zerelda Gray Sanders Wallace, was a prominent suffragist and temperance advocate. When Wallace's father was elected as lieutenant governor of Indiana, he moved his family to Covington, Indiana. Wallace's autobiography contains many descriptive stories of this boyhood in Covington, including the account of the death of his mother in 1834. In 1836, at the age of nine, he joined his brother in Crawfordsville, Indiana, where he briefly attended Wabash Preparatory School. Afterward he joined his father in Indianapolis.[2]

Wallace was studying law at the start of the Mexican-American War in 1846. He raised a company of militia and was elected a second lieutenant in the 1st Indiana Infantry regiment. He rose to the position of regimental adjutant and the rank of first lieutenant, serving in the army of Zachary Taylor, although he personally did not participate in combat.[3] After hostilities he was mustered out of the volunteer service on June 15, 1847.[4] He was admitted to the bar in 1849. In 1851 he was elected prosecuting attorney of the First Congressional District of Indiana.[2]

On May 6, 1852, Wallace married Susan Arnold Elston by whom he had one son, Henry Lane Wallace (born February 17, 1853). In 1856, he was elected to the Indiana State Senate after moving his residence to Crawfordsville.