This is a joke phrase, a sort of automatic punchline that turns an innocent piece of speech into startling and humorous innuendo.

Some examples:-

“You always give me a hard time.” Ordinarily this means, “You intentionally make things difficult.” But because the word “hard” can refer to the state of an erect penis, saying “that's what she said” (TWSS) changes the meaning to something like, “You like having sex with me.”

“It sure is wet today.” Ordinarily this suggests that it's been a rainy day. But because the word “wet” can refer to the state of an aroused woman's vagina, “TWSS” changes the meaning to something like, “I am a sexually aroused woman.”

Examples are infinite. So varied is the English terminology for sexuality that almost any statement can be transformed by TWSS. “We don't have time to stop for gas.” TWSS. “I've paid my dues, why can't I come inside.” TWSS.

While it’s not clear exactly when that’s what she said emerged, it does appear to continue in long tradition of innuendo. It may be based on a form of wordplay known as Wellerisms, named after a character in Charles Dickens’s The Pickwick Papers. Wellerisms make puns out of idioms and cliches for humorous effect, e.g., “’Let’s dig up that body,’ he said gravely.” It may also harken back to a double entendre popular in British English in the early 19th century, e.g., “‘Why don’t you come inside,’ said the actress to the bishop.” Alfred Hitchcock used a variation of the vulgar joke in a test reel for his 1929 film Blackmail, “‘It will not come out right,’ as the girl said to the soldier.” This is popularly cited as the first that’s what she said joke.

That’s what she said appears in print as early as Edmond Addeo and Robert Burger’s 1973 book EgoSpeak: Why No One Listens to You: “The cheapest shot of all, of course, is the ancient one-liner, ‘That’s what she said.’ This reply can be used after virtually any remark, however innocent, and the speaker can summon up some hint of double-entendre.” Its first appearance on TV is popularly credited to comedian Chevy Chase on a 1975 “Weekend Update” skit on Saturday Night Live.

That’s what she said became a popular catchphrase on Saturday Night Live’s late 1980s and early 1990s “Wayne’s World” sketches. These starred Mike Myers and Dana Carvey as two metalheads broadcasting a show from their basement. The character of Wayne (Mike Myers) would often fire off that’s what she said jokes. For example, in one scene, Garth says he’s “getting tired of holding it,” and Wayne replies, “Yeah, that’s what she said.” When “Wayne’s World” spun off into a film series in 1992, that’s what she said made its way to the big screen as well.

In the 2000s, the joke was a popular one-liner from character of Michael Scott in the US remake of The Office. Since Michael Scott (Steve Carell) plays a lovable loser with an ill-timed, groan-worthy sense of humor, his frequent that’s what she said jokes were were considered tired and old hat in the universe of the show, not to mention inappropriate in an office setting. The Office is filled with that’s what she said jokes. For example, in one episode Pam says that her mother is coming, and Michael responds “that’s what she said.”

On February 15, 2007, engineering student John Hughes launched an “International That’s What She Said Day” on Facebook, which gained a following of 148,477 fans. In 2012, the phrase was also used as the title of a popular comedy film starring Anne Heche.

That’s what she said is a form of innuendo that takes innocent statements out of context and makes them sound lewd or sexual.