Canon Lenses - What do I need?

Background blurring is also called bokeh effect. The best bokeh effect usually requires a large aperture lens with f/2.8 or larger. The 50mm f/1.8 or 85mm f/1.8 can give you a nice blurry background easily.

You also try your current tele lens, bring your horse close to you (just enough distance to get a sharp focus and fill the frame) and far away from the background, choose the largest aperture (smallest f number) and see if you can get some blurry background. If your horse is close to the background, then you won't get the bokeh effect. The farther the background, the more blurry it becomes and the more your subject will stand out.

There is another way to do bokeh effect. Alien Skin software Bokeh can let you blur the background to your heart's content, simulating expensive lens bokeh effect. You can transform all your old favorite photos and make them look like you took them with a f/1.2 or f/1.8 lens. This software costs $200 and you can work on any photos taken by any lens in your bag.

Obviously it is always better to use a better lens and better skill to take a photo than to do software repair or enhancement. If you choose to use software to fix the photo, then use it sparingly and try to make it look natural. If you overdo it, the photo can look worse than the original, kind of like some bad plastic surgery.

I am fairly efficient with Photoshop, and I've done a lot of photos with the faux blurred background, but I am much better with working on the photos after the fact than taking them. I'd much rather be able to achieve the real thing for time's sake.

Also, with Equine photos, most are taken at quite distance away since you're getting action and still shots and full body, etc.

That photo of the blurred background was taken fairly close. If you want the farther away shots with the subject taking up most of the shot then you're going to want to look into a either a 70-200 F2.8 or if you have the cash, a 300mm F2.8 prime lens. You can get the Sigma 70-200 F2.8 HSM for around $700. The 300mm F2.8 from Canon costs $4,400. The 300mm F2.8 is one of the lens you always see on the sidelines at NFL games, so the person can get that separation of the subject from the background(blurring the background).

The Sigma 70-200 F2.8 is the lens I thought I needed, but I wasn't certain, so now that I know it should give what I'm looking for for sure, I figure I will get that. I couldn't opt for the 300mm at this point.

You can go to http://www.lensrentals.com/ and rent the lens for a week and find out if that's going to work out for you. Also, don't get frustrated at first because it takes some practice shooting moving action with an F2.8 lens. The shallow depth of field will make it hard, plus learning to track objects with focus takes practice.

What would be my best option for lower light situations, close-ups for indoor use?

Yes the above posted photo shows some of the limitation of a smaller aperture lens, if that was shot wide open. The 70-200 F2.8 should work for many indoor shots, meaning more of a building and not a home. For a home shot, you'd want to look more at a 50mm F1.8 or 1.4 that was discussed earlier.

Your budget seems to be flexible. The 50mm f/1.8 lens is usually bought by the budget minded, quite a difference from someone considering a f/2.8 zoom.

Since you are shooting large animals, having both wide angle and tele zooms may give you more flexibility. I personally use the EF-S 17-55mm f/2.8 IS on the 30D, and the EF 70-200mm f/2.8L IS on both the 30D and 5D Mk II. These 2 zoom lenses have great image qualities and very nice bokeh effect. They are also very flexible, suitable for a very wide range of subjects. I have the 50mm f/1.4 lens but hardly use it since these 2 zoom lenses seem to be adequate for most of my indoor/outdoor shots. The Sigma 18-50mm f/2.8 and 70-200mm f/2.8 are much cheaper and still have decent quality.

The 85mm f/1.2L lens is Canon's best portrait lens, and the 85mm f/1.8 is also quite good, better than the 50mm f/1.8. But the fast zoom f/2.8 lenses are much more flexible and fun to use.

Indoor/low light portraits will need some good external bounce flashes or strobes. For good portraits you need to learn about portrait lighting.

I can afford the 70-200mm f2.8 by Sigma, but if I buy that, that would be it for now, and I'd ideally like something for portraits and a new flash since I can't get my Vivitar 285HV to synch with the XSI(which is probably my fault)

Use the 70-200 F2.8 now and you'll find that it's a wonderful portrait lens. I've seen videos of portrait pros using the 70-200 F4 lens and producing wonderful shots.

These are some of my own photos using EF-S 17-55mm f/2.8 IS and the EF 70-200mm f/2.8L IS. These are all done handheld, without tripod or flash.
http://s165.photobucket.com/albums/u45/hjfok/DOF/

The first photo is done in extremely low light, lit by the candy cane light only. You can see the blurred background of Christmas lights at the background. This shot needs the IS, otherwise you need to use a tripod. The butterfly and the alligators were shot with the 70-200mm lens. As you can see, the closer you get to the subject, the better the bokeh effect (obviously the background needs to have some distance). The horse photo with bokeh effect that you showed is taken at close range too.

Here are some sample photos of different lighting using the same lenses (except the last photo, using EF 24-105mm f/4L IS).
http://s165.photobucket.com/albums/u45/hjfok/Lighting/
http://s165.photobucket.com/albums/u45/hjfok/Knight/

The first photo is done in extreme sunlight around noon with a lot of contrast and shadow. Using a small amount of fill flash or using a reflector can help the shadow detail. Second photo is taken in semi overcast day and there is an obvious difference, just a simple straightforward snapshot. The third one is done at dusk and I want to get the softer water flow look of the fountain with its nice background lighting, so the shot was done wide open at f/2.8 with shutter speed slowed down to 1/60, this needs IS or tripod. The fourth one is done at extreme low light, care needs to be taken not to overexpose the photo which will give a lot of noise. In this case I just want to use the candy cane light to highlight the expression on his face, so it works. But in general it is not good to take portraits in extreme low light, even with a fast wide aperture lens. The fifth photo is a straightforward typical indoor bounce flash photo with a diffuser. You generally need flash for indoor portraits. The last photo is a fun Halloween Chroma Key shot. The last portrait and the other knight shot are done with green screen and 2 strobes with umbrellas (kids have no patience, so I don't have time to do a more sophisticated setup). The background is taken separately a couple of years ago, and merged by using layers in Photoshop. This is just to show that lighting is key to taking portraits. The wide aperture lens will give nice bokeh effect or achieve some special effect in low lighting, but a lot of fun portraits can be taken without a shallow depth of field.

I'm not a pro, just want to share something that I learned after using the D-SLR for a little while. For portraits, the lens and the lighting equipment are equally important. I don't have a passion in equine photography and don't have any horse photos to show (just my kid riding pony). So I included a few photos to let you see whether this is something you're looking for. I usually don't need a wider aperture than f/2.8 for my family photos, and like the flexibility of the wide aperture zoom lenses.