I finally solved the issues with host-only networking and internet connection sharing. When I set up host-only networking, and turned on internet sharing on the host mac, I got a warning to also turn on personal web sharing. This was an issue because it started an unneccessary service on the host, and only allow web browsing with the VM, but no other internet apps worked. I also found that turning off the Mac FW allowed the internet sharing to work properly. So I went to the advanced tab in firewall prefs and turned on FW logging. There I could see that the FW was blocking the ports I was trying to use. So I made a new rule in the FW prefs, and simply listed the ports I needed to use: 80, 443, 22, 5190. Viola! It now the FW can stay turned on, no unneccessary services need to be started, and only the ports needed are opened. Someone more advanced in ipfw could even write rules to only open those ports for the VM, but this works for a quick fix. BTW, the original issue I was trying to solve was getting internet sharing working between two Macs, but using Parallels and a VM, I was able to troubleshoot the issue with just one machine. I hope this helps someone else.
