Stale and artificial are the result of not using your flash correctly. I'm no expert with flash, so I'll leave it to others to guide you on that subject.
Basically, you're running up against the learning curve. You're finding that not every shot is doable with what you have. If you can't get the shutter speed you need at the aperture you want, you boost ISO. If your camera doesn't perform well at higher ISOs, you use a tripod and slower shutter speeds. Slower shutter speeds will require the wee lad to hold still, and that's often easier said than done with young ones. If none of these options are viable, you use flash. When lighting is done correctly, it will actually make your picture pop. Done incorrectly it will look washed out and flat.
Given the equipment you have, the kit lens might be your best bet for this shot. I'd set it at about 30mm, set the aperture as wide as possible for that focal length, ISO no higher than 800, and with the IS on, the extra stops will probably be enough to get the shot. But remember, IS counters camera shake, not subject motion. If your nephew is moving, he will be blurry, while anything in focus that's stationary will be sharp.
The 50 1.8 is more capable than you're seeing right now. You've run up against the limits of lens and body in this particular situation. Again, get your nephew in a well lit environment where you can shoot at f3.5, and you'll see how well this lens can perform.
