Claudio Marchisio's ninth-minute goal had put the hosts in front and Italy should have extended their lead but were twice denied by the woodwork in the second half.
Maxine Chanot pulled Luxembourg level with five minutes remaining when he nodded past a helpless Gianluigi Buffon in the Italy goal.
Italy will now try to put the embarrassing result behind them before their World Cup opener against England on June 14 in Brazil.
Cesare Prandelli, who named his 23-man squad on Sunday, has one more warm-up game against Brazilian club side Fluminense on Sunday.
A crowd of 25,000 turned up at the Renato Curi stadium to support the Italians in their last test before travelling to Brazil on Thursday.
Prandelli's side played for the first time since losing midfielder Riccardo Montolivo to a fractured shinbone in Saturday's goalless draw with the Republic of Ireland.
Italy had seven changes to the side that started against the Irish in London.
The Azzurri lined up with a 4-5-1 formation, with Andrea Pirlo and Marco Verratti playing at the heart of midfield and Mario Balotelli operating as the lone striker.
Luxembourg had the first chance of the game in the seventh minute with Joachim's bullet strike from 30 yards but it was saved by goalkeeper Gianluigi Buffon.
Italy went ahead two minutes later when Marchisio's powerful close-range header from Balotelli's cross beat Luxembourg goalkeeper Anthony Moris.
Balotelli then wasted a good chance to double Italy's lead in the 14th minute when he got behind Antonio Candreva's cross but hit the ball over the bar from the heart of the area.
On the half-hour mark, Verratti spotted Balotelli in the area and the Milan forward's goal-bound attempt was saved by Moris, who was called into action again before half-time to clear Pirlo's curled free-kick.
Prandelli made his first substitution early in the second half with Antonio Cassano replacing Verratti.
The home side looked more dangerous and were unlucky not to add to their advantage in the 56th minute.
Cassano sent Balotelli through and the striker surged into the box.
He hit the ball past Moris but his effort hit the crossbar.
The Azzurri fans could not believe their luck when Candreva got behind Balotelli's cross and his header again found the bar with Moris already beaten.
Luxembourg, who had lost their previous eight encounters against Italy, sprung a surprise when Chanot got past his marker and headed Mario Mutsch's cross from a corner kick past Buffon.
The Azzurri's Ignazio Abate hit a drive from 30 yards that was kept out by Moris and the match ended in a 1-1 draw.