The problem of Rabi oscillations in a qubit coupled to a fluctuator and in contact with a heath bath is considered. A scheme is developed for taking into account both phase and energy relaxation in a phenomenological way, while taking full account of the quantum dynamics of the four-level system subject to a driving AC field. Significant suppression of the Rabi oscillations is found when the qubit and fluctuator are close to resonance. The effect of the fluctuator state on the read-out signal is discussed. This effect is shown to modify the observed signal significantly. This may be relevant to recent experiments by Simmonds et al. [Phys. Rev. Lett. 93, 077003 (2004)].
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