In the U.S.A any amount earned over $600 even as a gift has to be filed with a 1099. Even If you are not reporting your "gifts" paypal still reports them (this is a new thing). And
YES gifted money is included. It is up to you on your tax form to declare and what not. FYI, gifted money (unless you use the one time exemption) is technically taxable: i.e. if Grandma gives you $100 for your birthday vs. Grandma gives you $10,000 one time gift to avoid taxes. Further more, how does one expect Paypal (and others) to differentiate what is a gift and what is not? If you don't pass the threshold, the point is mute. But if you do pass the threshold and you happen to have gift money and business money, then the IRS will expect you to clear it up when you file. Just saying...I was just looking out for Abbey and you as well Dave.
Check out this link as "gift" scams have been being used for a long time. On a side note if you choose to pay taxes on your paypal earnings before a red flag is waived then you should be fine.
http://answers.yahoo.com/question/index?qid=20120819203102AAeGWfy
https://www.paypal-community.com/t5/About-Business/1099k-if-money-sent-as-gift/td-p/602441
some of this was copied and pasted from this second link cause i didnt feel like typing the same thing.