You have a large number of options really:
1. Boot from that thumbdrive, but mount your NTFS partitions using the 'ntfs-3g' driver so that you can read/write data to it.
2. Install Linux to your HD (I see posts stating that the latest partitioning tools can even resize NTFS partitions) and dual-boot Linux or XP as needed.
3. Install Linux to the HD and then install VirtualBox and install XP inside that; this allows you to run Linux and XP simultaneously. It also allows you to reboot XP without rebooting the machine.
It also puts some limits on the damage that typical malware will do - well, the malware can totally screw the XP stuff, but the damage it can do to the Linux system is limited - unless of course it is malware which is specifically written to do damage to a Linux system running XP in VirtualBox. (I don't know of such malware yet.)
4. Install Linux to the HD and install WINE to run your other software which must run under WinDuhs. I would suggest this in tandem with (3) because you may have to tinker a bit to get your software running. Some software just won't run even in WINE, in which case your only option is (3). The catch with (3) is that WinDuhs will not have access to USB devices like webcams and so on - unless you switch to the paid-for version of VirtualBox.
I have seen posts where people have said that PuppyLinux only has a 'root' user - I dont know if that's true but it's definitely something to investigate. If the claim is true, then dump Puppy for something like Kubuntu instead. You can still use options 1-4 running with Kubuntu (or any other Linux distribution for that matter).
Take your time getting rid of XP (if you can get rid of it at all); trying to dump it all at once will definitely have you screaming and tearing out your hair.
The safest option to use until you've checked things out and discovered the shortcomings of VirtualBox or WINE, is to have a dual-boot system with XP but with VirtualBox + XP under Linux as well. The down side to such an install is that you use up an awful lot of space with XP essentially installed twice.