I have the following xaml:
Because MenuItem is the container type and when it translates your view model into visual item it will wrap your template in MenuItem. In the same way ListBox will create ListBoxItem or ListView will use ListViewItem. To bind properties of the wrapper you need to use ItemContainerStyle
<ContextMenu ItemsSource="{Binding TestItems}">
<ContextMenu.ItemContainerStyle>
<Style TargetType="{x:Type MenuItem}">
<Setter Property="IsChecked" Value="{Binding IsSelected}"/>
<Setter Property="Header" Value="{Binding Header}"/>
</Style>
</ContextMenu.ItemContainerStyle>
</ContextMenu>
or, if you prefer, you can do it partially with ItemTemplate and ItemContainerStyle
<ContextMenu ItemsSource="{Binding TestItems}">
<ContextMenu.ItemTemplate>
<DataTemplate>
<TextBlock Text="{Binding Header}"/>
</DataTemplate>
</ContextMenu.ItemTemplate>
<ContextMenu.ItemContainerStyle>
<Style TargetType="{x:Type MenuItem}">
<Setter Property="IsChecked" Value="{Binding IsSelected}"/>
</Style>
</ContextMenu.ItemContainerStyle>
</ContextMenu>
In this scenario whatever is in ItemTemplate will become MenuItem.Header but IsChecked property still needs to be bound in ItemContainerStyle