See section 5 of TS1538: iOS: Device not recognized in iTunes for Windows.
If that doesn't help it may pay to tear down and reinstall iTunes in the following manner...
Go to Control Panel > Add or Remove Programs (Win XP) or Programs and Features (later)
Remove all of these items in the following order:
- Apple Software Update
- Apple Mobile Device Support (if this won't uninstall press on)
- Apple Application Support
Reboot, download iTunes, then reinstall, either using an account with administrative rights, or right-clicking the downloaded installer and selecting Run as Administrator.
The uninstall and reinstall process will preserve your iTunes library and settings, but ideally you would back up the library and your other important personal documents and data on a regular basis. See this user tip for a suggested technique.
Some users may need to follow all the steps in whichever of the following support documents applies to their system. These include some additional manual file and folder deletions not mentioned above.
I had this same problem with the 126.96.36.199 upgrade yesterday also. I followed numerous troubleshooting steps from Apple's website, but nothing helped. The only solution was to completely uninstall ALL Apple software from the Windows Control Panel "Programs and Features" section, then download the new iTunes directly from Apple's website, and run the installation from scratch. I took the extra precaution of rebooting my iPod Touch before attempting to sync it again. Steps for that can be found here: http://support.apple.com/kb/ht1430
Everything is working fine now, and all my content and settings were preserved in iTunes.