TrueCrypt creates a disk object by inserting itself as a translation layer above an existing container - typically a partition or an entire disk, sometimes a file which will therefore contain a disk image. You then format that disk created by TrueCrypt using NTFS or FAT or EXT4 or whatever you want. TrueCrypt neither knows nor cares about the files on the disk, it just encrypts the disk raw. Used space, free space, deleted files.. everything. It's the disk that's encrypted, and therefore any files on it are by extension also encrypted because they're in an encrypted container.
Windows built-in encryption is based on NTFS -- the filesystem used by Windows. NTFS takes an existing disk and decides where on it to store files. It keeps track of used blocks, file names, the location of file contents, file fragmentation, all of that. It's the set of rules used to decide where on the disk a given file goes.
Built in to the NTFS spec is the idea of encryption. Key handling is done through windows, but the important point is that the encryption happens transparently when the file is stored to disk. If the file is marked as encrypted, then NTFS will transparently encrypt/decrypt the file as it's reading or writing from the disk.
You can create a TrueCrypt container and format it with NTFS. In that sense, the entire filesystem will be encrypted, but Windows won't know that. All Windows sees is the disk object exposed by TrueCrypt. It doesn't know (nor does it have to know) that TrueCrypt is transparently encrypting that data before writing it to disk. But it is.
Within that NTFS filesystem in the TrueCrypt container, you an also instruct Windows to encrypt the file. It tells the NTFS filesystem that this file is encrypted, and NTFS will dutifully encrypt the file.
Now the file appears to be in plain text to the user, but actually when it's stored to disk, the filesystem is transparently encrypting it. And then again when those encrypted bits are actually written to the physical disk, TrueCrypt is getting in there and encrypting those data blocks again, so the file is encrypted, and the disk that the file is on is encrypted.
Both are done transparently, and the whole process just works. Obviously you'll need both keys to get to the actual file data. The TrueCrypt key is your TrueCrypt password, while the Windows NTFS key is typically an x.509 private key encrypted with your Windows login password.
: Not entirely accurate, but accurate enough for this discussion.