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I’m unsure which is correct here.

I use XBOX series X with ARC, sub and two one SL.
XBOX series X outputs Atmos by default but ingame i can choose between these:
Default, stereo, quad, 5.1, 7.1 and Pro Logic.

What is correct here?
Does Default option ingame use Atmos or should i set 7.1 and then XBOX outputs ATMOS from that setup? This is confusing me.

Also, is my setup a 7.1 setup or a 5.1 setup?

Your setup is 5.1.2. With non-Atmos content, I recommend setting the HDMI Audio setting on the Xbox to 5.1 uncompressed. Then choose the 5.1 option ingame. These settings should result in “Multichannel PCM 5.1” audio displayed in the Sonos app.

Only use the “Dolby Atmos for home theater” setting when playing native Dolby Atmos content.