I found the solution. You need to fiddle with the QStyleOptionGraphicsItem *option that is passed to the paint function.
My custom widget subclasses QGraphicsPixmapItem. I had reimplemented the paint function to call the regular paint funct and then my custom stuff. What I do now is as follows
myoption.state &= !QStyle::State_Selected
.... my own drawing routines ....
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So I trap option, unset the option.state QStyle::State_selected bit, and then pass it on. I then have my own code for indicating its selected.