Further details here.
Selena Kitt also weighs in here. (Following the link embedded in the first article doesn't take you to the correct page.)
I don't think that it's helpful to be pissed at Smashwords, as they are clearly unhappy with the decision. The only online vendor in my memory who has stood up to Paypal making an ultimatum like this is the Dreamwidth journaling service, which has an ideologically unique and dedicated user base that was willing to tolerate a lot of inconvenience while Dreamwidth found a new payment processor. Smashwords can't claim that; users are not going to wait weeks for a $.99 impulse title. And I'm honestly not sure what a good plan of action would even be to deal with this, except to spread the word and get an especial chill at the inclusion of BDSM titles under "rape." While rape, bestiality, and incest are all illegal and immoral in their real-world incarnations, consensual kink is not, but practitioners are still often targeted for persecution.
Anyway. I'll defend to the death your right to say it, then they came for me, I'm sure you can fill in your own cliche at this point.
Edited for my inability to walk away from ANYTHING: It has been pointed out hither, thither, and yon that this is not a First Amendment issue of free speech. This is true; a retailer does not have to carry any products, or businesses entertain any customers, that they do not wish. The First Amendment protects against government interference in free speech under most conditions*. It does not guarantee that your speech is protected from criticism or that you are guaranteed an audience. However, the fact that there is no real legal issue of free speech at work here does not mean that there is no moral one. Acts depicted in fiction, no matter how personally distasteful you might find them, do not do material harm to real world persons. I don't like tapioca pudding. (WHY WOULD YOU EAT SOMETHING THAT LOOKS AT YOU.) Without being able to come up with a rational and verifiable basis for its causing harm, though, I cannot on moral grounds object to it being sold. This is most apparent with the inclusion of BDSM in the list of banned themes. (I'm still waiting for one of the pro-Paypal people to provide a good explanation for this on moral grounds, by the way, or even to address it at all.) Incest, rape, and bestiality practiced in the real world would cause material harm to persons and animals. Though I think that it can be successfully countered, the argument can be made that the portrayal of these acts in a fictional context encourages their real-life practice. Consensual BDSM, however, is neither illegal nor immoral in its real-life context. It is simply, to some, "yucky." Yeah, that's not an impressive ethical or moral stance among grown-ups.
*Stop citing the Miller Test until you know what it means, though. Just stop.