I used Paypal to accept payment for an editing assignment. As soon as I got the payment, I transferred it from Paypal to my bank account, figuring that I was safe. After I completed the work, the client apparently did a chargeback on his credit card, so Paypal did the logical thing: withdrew the money from my account retroactively.

I wrangled customer support, got nowhere, and had a fat negative balance in my account, but I figured I was okay -- until six months later, when I got sent to collections, when I gave collections the money and then sued Paypal in small claims court (this might not have been the wisest move in the world; given recent experiences: http://jseliger.com/2010/08/28/dont-rent-an-apartment-from-n... , I don't think I'd bother with the same course of action today). Their EULA says you can't do that, but they offered me half the money to make me go away, which I did.

The moral of the story: I no longer use Paypal. Ever. For anything.

Moral #2: the horror stories are real.

EDIT: One other thing -- if you are selling virtual services, Paypal will not back you up. If I'd been smarter, I would've shipped something to the client's address, with a tracking number, which might've helped me.