Telling someone they are not hired is never an easy job, but all hiring managers will face this dilemma many times in their careers. While everyone fears denial on some level, it is important for all to understand that not everyone will fit in every job. Further, there are times when the applicant quality will be so great, a decision to reject an applicant may not reflect on that applicant's abilities but the overall quality of the field.
There are a number of methods that can be used to get the message across that a person is not hired. In many cases, especially for those who were never called for an interview, a simple form letter may suffice. In other cases, where someone may have been called for an interview, a phone call or letter could be chosen to deliver the message they were not hired. In cases where there may be an ongoing relationship with the person not hired, it may be best to break the news in person, though this has the obvious potential of being more uncomfortable.
Above all, it is best to always be honest with those who didn't get the job. If there may be a future position they may fit, let them know. However, do not just say that to ease the pain. While it is always good to let someone down easily, there are limits to how far one should go to accomplish this. Lying is never acceptable.
Most applicants understand there is usually only one available position and multiple applicants vying for that spot. Therefore, most will understand if they are not hired. Some may take it personally, but many will be very professional about the situation. For those applicants who do take it personally, understand this verifies you likely made the correct decision in not hiring that person.
In all cases, even if you felt someone misrepresented themselves to obtain an interview, never be condescending with the news they are not hired. This is unprofessional and reflects very poorly not only on the hiring manager, but the organization as a whole. Yes, there will be times when a person is so desperate they may misrepresent themselves, but it is best to chalk this up as a hazard of the position and move on.
Generally, it is not a good idea to tell someone specific reasons why they were not hired for a job. This can only lead to resentment and regret. However, there may be specific times when this could be a good idea. For example, if an applicant was promising and the hiring manager believes another position will be opening up that suits the applicant's skills, this could be a way to let that person know they may soon have another opportunity.