Gems are Ruby libraries; they are the subject of my earlier book,
Practical Ruby Gems. Rails itself is packaged as a gem, and so are a variety of other Ruby software packages: fasterCSV is an optimized CSV library packaged as a gem, hpricot is an HTML parser library packaged as a gem, and so forth.
Plugins are specifically designed to extend Rails; they are placed inside a Rails application and are automatically loaded by Rails. Unlike Gems, they are unique to an application: if five of your apps use the Attachment Fu plugin, all five will contain a separate copy.
However, the two types are not completely inseparable: you can, for example, copy a particular gem to your Rails plugin directory; this causes that particular version of the gem to be "frozen," so that your application will always use that version instead of whatever version is most recent.
Additionally, Rails 2.1+ supports packaging plugins as gems; as a result, the essential difference between gems and plugins becomes whether your Rails application is going to load the code from your system or from it's own local copy.
Take it easy,
David Berube