I removed my brake pads last night and I noticed that the rubber part of the piston that the inboard pad rests on has some small cracks and a little piece missing. Is this unsafe? Is it going to cause a leak?

Also what is the best way to retract the piston to it's open position? Is this the kind that has to be screwed?

 

The rubber boot is for dust and water protection. If the smooth surface finish of the piston gets some rust or dust particles it might damage the seal inside the caliper and consequently leak.
There is a special tool to push the piston, but you can gently push it with some pliers or put the caliper back on the mount and pull hard with the old pad in place.

 

if it makes you feel anybetter my piston boots are torn also......on most domestic car with disk brake rears that caliper needs to be turned in to compress. but the XJ just needs to be pressed in. take the master cyl resv cap off also when pressing the piston.

 

Consider getting some rebuilt calipers or rebuild them yourself with a rebuild kit. The rubber boots would be part of a rebuild kit. Calipers and wheel cylinders are the most neglected part of a braking system and are easy/cheap to replace/rebuild.