Do you mean subdomains? Im not sure what actual effect subdomains have on SEO, but I do know that each category in wordpress will add another page to your website, listing all the posts in that category. If you use keywords to label your category and optimize the 'archive' or 'category' page of your theme, using an h1 tag for the category label and displaying a description on the page to incorporate related keywords, it can be helpful.

Hope this helps!

If you are using mod_rewrite (settings -> permalinks in wordpress) then yes they can function like subfolders.

By editing the permalink structure in Wordpress you can setup the directory structure however you like.

Eg.

yoursite.com/category1/
yoursite.com/category2/

Thanks, guys.