When i cite a book source, would this be correct:
......, according to the book: James Madison on Religious Liberty.
with the title in italics

I would write:

...according to Robert S. Alley in "James Madison on Religious Liberty"...

Your school probably has its own conventions. Yes, I have used italics for titles, also.

That's correct. See the exemplary usage on this page:
http://www.freedomforum.org/templates/document.asp?documentID=3963

If this or another answer here proves helpful in your research, you can encourage good answers by choosing one answer as the "best answer."

Cheers,
Bruce

I think everything but the use of the colon is correct.

I don't see why you need a colon there. Of course I don't see the whole sentence either, but colons are serious business, right up there with a period they nearly cause a full stop in reading. I would put no punctuation there at all, for the words read smoothly that way. Read it out loud and see.