IIRC, the S4E2 plot stated that Little Planet was approaching Sonic's world as the story began. So it probably would have eventually entered its atmosphere if Eggman hadn't captured it and turned it into his new Death Egg. When it's not within the planet's atmosphere, it likely orbits in space. This is consistent with the SCD manual, which describes it as "a small, yet beautiful star" that comes to the sky above Never Lake once a year, implying that most of the time it looks like a star in space. This also implies that it orbits the sun rather than the Earth, otherwise the manual would have called it a moon.