The vehicle, believed to have been driven by Graeme Schoneville, went out of control on a hairpin bend and flipped over, before crashing into a tree and landing on top of the woman, named as Joy Robson, and the child, who are understood to not be related.
Both the 50-year-old woman, a nursery teacher from Portree , and the young boy were pinned under the yellow Honda Civic while around 20 spectators tried to lift the vehicle off them.
Northern Constabulary confirmed the woman had died of her injuries while the boy was treated at the scene before being taken to Raigmore Hospital, where his condition was said not to be life-threatening.
A third spectator who suffered minor injuries was described by police as "walking wounded".
The accident happened during the high-profile annual Snowman Rally cross-country event, the opening event in the ARR Craib Scottish Rally Championship. Yesterday's event was immediately cancelled.
Neither Schoneville, a leading 1600cc competitor from Lanarkshire and member of the Coltness Car Club, nor his co-driver, Michael Hendry, was hurt in the accident, which happened at around 10.30am.
It occurred six miles into the opening nine-mile leg of the Highland Car Club rally at Balnain in Glenurquhart Forest, about five miles west of Loch Ness.
Eye-witness Kyle Reid, 21, a rally enthusiast from Inverness, revealed he was just yards away when the horror unfolded.
He said: "We were standing near a fast corner leading into a hairpin when we saw this yellow Honda Civic come round the bend. It must have been slippy at that part because most of the cars were sliding off it down into the hairpin.
"We think it must have hit something because it tipped over onto its side and careered into a tree where there was a man with his two kids and an older woman standing.
"The car wiped out the tree, one minute it was there, the next it was gone and the impact must have righted the car. But the woman and the boy were trapped underneath.
"There was loads of screaming and we rushed over to the scene with around 20 other spectators to lift the car off the woman and the wee boy.
"It all happened in seconds and with so many people it didn't take long for us to get the car off them. Both were conscious at the time.
"We spoke to the boy's father, who was also there with his daughter, and he said they had stood behind the tree because they thought it was safer.
"The woman had been trapped under the driver's wheel and was lying in the recovery position until the ambulance staff arrived.
"She was complaining of a sore back and side and the paramedics strapped her to a board before they moved her.
"The little boy was carried to a Jeep with a flat bed where he waited for the ambulance men. We all got a shock. It is rare for accidents like this to happen and we are all desperately sorry for the woman's family. Hopefully the boy will be OK."
Dave Robson, chairman of the Scottish Rally Championship, said: "The management committee, competitors and officials of the SRC extend their condolences to the families of those involved in today's incident on Special Stage One of the Snowman Rally. We offer our committed support to Highland Car Club and all those affected at this difficult time."
A statement from Highland Car Club added: "The club extends its sympathies to the families of those involved."
Around 20,000 spectators usually turn out to line the various routes of the tight, fast and slippery forest stages of the 44-mile rally, in which cars race against the clock.
Organisers Highland Car Club had issued safety advice ahead of the event. As well as advising spectators where not to stand, it warned: "Always expect the unexpected, listen for approaching cars, remain alert, leave yourself room to move quickly, try to keep behind something solid, keep children under supervision."
It is not the first accident for the Scottish rally scene. In 2010, Scots rally champion Jimmy Girvan, 56, died instantly when his Subaru Impreza spun out of control, trapping his co-driver and main sponsor Mike Ramsay inside the wreckage.
The accident happened in the Griffin section, east of Aberfeldy, during the Hankook Scottish Rally Championship.
An investigation into yesterday's accident is being carried out by Northern Constabulary and a report will be sent to the procurator fiscal.
* Two teenagers died in an early morning crash in North Lanarkshire when their car hit a telegraph pole and two trees.
Police said the pair, both 19, died when the Renault Clio left the road in Shotts at about 1.50am on Saturday.
They were later named as Scott Wilson, 19, of Carey Gardens, Cleland, and Steven Scott, 19, of Bonaccord Crescent, Shotts.
Two other men, aged 17 and 20, were injured in the crash and taken to hospital.
The 20-year-old, who suffered a punctured lung, was said to be serious but stable, while the 17-year-old broke his leg.