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What is the ruling in Islam regarding categorization of Muslims into sects like Sunni and Shia? Does Allah allow/disallow it in Quran? What did Prophet (P.B.U.H) say about it?
Would it be a sin if I label myself one of those groups as opposed to just Muslim?
Yes it is. Creating and supporting sects is a great sin. Quran says Ar-Rum/32:
مِنَ الَّذِينَ فَرَّقُوا دِينَهُمْ وَكَانُوا شِيَعًا كُلُّ حِزْبٍ بِمَا لَدَيْهِمْ فَرِحُونَ ﴿الروم: ٣٢﴾
[be not] of those who have divided up their religion, and become sects, each several party rejoicing in what is theirs.
It depends on the intention behind the categorization. The Prophet (saws) himself categorized the Muslims of his time as Muhajirin and Ansar. BUT at the same time, when one of the Companions used a different categorization to put someone down and insult them, the Prophet (saws) was quite firm in telling them to cut it out.
Having said that, there is a well-known hadith about the ummah splitting into 73 sects: http://sunnah.com/abudawud/42#2 . So the lesson from the hadith is beware of identifying with a sect that is destined for jahannam.
There are a couple of issues here. One is an actual sect (something that differs in theology) versus a madhhab (school of thought, codified set of rules on how they approach fiqh). I don't know which you're asking about, so I'll talk about both.
A sect differs in aqedah (belief, theology). This includes groups like the Khawarij, who existed at the time of rasulullah.
Referring to sects, rasulullah said: "You will divide into 72-73 (depends on the narration) sects like the nations before you, all of them will be in the Fire except one." (Source: Abu Dawud) The one refers to "At-Taif Al-Mansoorah," the saved sect, aka. the teachings of rasulullah and then his companions and then the scholars of Islam. In Sunni Islam, we believe that we are that one saved sect, because we are on the fitrah of Islam, and on the teachings of rasulullah (his sunnah).
As for mathab/madhab/mazhab, this refers to a scholarly division in usool-ul-fiqh. The four popular ones, as well as many others that did not survive, are all headed by scholars who approached fiqh (deriving rulings) with a certain methodology. Different madhabs used different methodologies; those are not considered sects.
A Muslim is first a Muslim. Quran (verse 3:19) states that the only religion accepted by God is Islam (which means submission to him and his will).
The divisions between Muslims are mainly regarding the matters of Islamic jurisprudence. Quran seems to imply that God dislikes believers creating and emphasizing divisions between them (c.f. Sura Al-Anbiya, particularly verses 91-93, Sura Al-Mu’minoon, particularly verses 51-54).
Islamic scholars and schools have different opinions on various issues and it is fine to refer to oneself to state the school one is following. On the other hand overemphasizing the school one belongs to so much that it comes before being a Muslim seems to be against Quran. A Muslim should not emphasize the secondary issues over the primary issues that are not disputed and are clearly stated in Quran like core beliefs (e.g. belief in God, the day of judgment, and the prophets) and core duties (e.g. Salah, Zakat).
In short, it seems that from Quran's perspective Muslims are all brothers and one Ummah, and emphasizing associations to a particular groups over being Muslim seems to be something that God dislikes and should be avoided. But if the categorization is not emphasized over being a Muslim then it can be fine, the same way we categorize ourselves as being from some city and that is not problematic.
