The band was first formed in the suburbs of Las Vegas by childhood friends Ryan Ross on guitar and Spencer Smith on drums. The duo would originally play blink-182 covers until they recruited fellow schoolmates Brent Wilson on bass and Brendon Urie on vocals and guitar. Their name was taken from a line in the song Panic (by Name Taken), in reference to a song of the same name by The Smiths.

In order to get their music heard, the band left comments through LiveJournal to Pete Wentz (of Fall Out Boy), linking him to their PureVolume site. Wentz was so impressed that he drove to Las Vegas to meet them personally. Then he referred them to Fueled by Ramen Records, who signed them (while they were still in high school) to Wentz's imprint label Decaydance. They recorded their debut album A Fever You Can't Sweat Out in College Park, Maryland with producer Matt Squire, who had earlier produced Thrice.

Lately the band has attracted a considerable amount of publicity, especially with Spin magazine, naming them as their band of the day in early October 2005. The band has also increased in popularity due to their online presence, with PureVolume having them consistently in their Top 10 signed band list and reaching #1 on the MySpace chart.

When A Fever You Can't Sweat Out was released, it debuted at #112 on the Billboard 200 album charts, at #6 on the Billboard independent chart, and #1 Billboard heatseeker chart, with nearly 10,000 in first week sales. The band started their first North American tour, supporting Acceptance, Hellogoodbye and The Academy Is... in September 2005, as well as The Academy Is... in the United Kingdom in January 2006.

Panic! at the Disco was featured on MTV's TRL on January 17, 2006, where they premiered their music video for "I Write Sins Not Tragedies", directed by Shane Drake. The group did not especially like the idea of appearing on TRL, due to the fact that a lot of fans would consider this move "mainstream". They posted a journal on their official website stating that it wasn't meant to happen, and they were against the idea and they apologize, but they received a lot of publicity as a result. The video for I Write Sins Not Tragedies, featuring Lucent Dossier Vaudeville Cirque, has an eerie circus wedding theme. It recently debuted at #10 on the TRL countdown, catapulting the album to the top of the Billboard independent chart and to #15 on the Billboard 200 in July 2006.

Urie and Smith recently made a cameo appearance in Fall Out Boy's latest video for their single A Little Less Sixteen Candles, a Little More "Touch Me", alongside William Beckett from The Academy Is.... Urie also provided backing vocals in a Fall Out Boy song called, "7 Minutes in Heaven (Atavan Halen)"

Panic! At the Disco's video of "I Write Sins Not Tragedies" is among YouTube's most-viewed videos, having been streamed more than 5 million times. It is also the most requested song on NY radio station Z100.

Their second music video, for the single "But It's Better If You Do", has a storyline involving the band playing in an illegal strip club in the 1930's in America. Brendon Urie commented, "Our new video is meant to show the fans the dark and secluded style of Panic." The single was released on May 1st in the UK and debuted (and peaked) at #23.

The band filmed their third video, "Lying Is the Most Fun a Girl Can Have without Taking Her Clothes Off". The video, which was released in July 2006, features people in fishtanks. The video only shows the band in one shot, because the band felt that their looks were distracting from their music.

In May 2006, Panic! at the Disco completed their very first headlining shows in Europe. All the dates were sold out, with some (notably the show in Manchester) selling out in hours. Afterwards, the band embarked on a two-month North American headlining tour with supporting acts The Hush Sound, OK Go, The Dresden Dolls, and Lucent Dossier Vaudeville Cirque.

On May 17, 2006, Panic! At the Disco made an official announcement via their website announcing the departure of their bassist Brent Wilson. No official reason was given for the departure of Wilson. The announcement stated that a long-time friend of the band, named Jon Walker, who has previously opened for bands such as Red Hot Chili Peppers, would be filling in for this summer's tour as a temporary bassist while the band searched for a permanent replacement. However on July 3, 2006, the band's myspace was edited to list Jon as bassist/vocals. Jon Walker is now considered a member of P!ATD.

According to MTV News, the band and Wilson have now engaged in a war of words, with Wilson stating in a Spin interview that he was fired without warning, opposed to the band's official statement that his departure was a decision all the band came to. In retaliation to Wilson's comment, P!ATD alleged that Wilson did not write the bass parts on their debut album or even played bass on the recording.

The band will later in 2006 embark on their first tour of Australia performing in Sydney, Melbourne and others.