Hello Sean
To achieve what you’re trying to do, you need something like this:
R1 and R2 are the devices that support L2TPv3. By configuring pseudowire on the Gi0/0 interfaces of R1 and R2, you are creating a Layer 2 tunnel between the two Gi0/0 interfaces on the routers, that is being tunneled through the Layer 3 underlay. The result is as if you are connecting two layer 2 ports of SW1 and SW2 directly.
The reason why you have to configure it on physical ports is that the pseudowire feature and the xconnect command can only be applied to physical Layer 3 interfaces. The mechanism of encapsulation actually takes place at the physical Gi0/0 interfaces of the routers.
You can configure the connecting ports of SW1 and SW2 as access ports or trunk ports. You can then span as many VLANs as you want across the Layer 3 infrastructure. They’ll function as if you have connected the switches directly to one another. Does that make sense?
I hope this has been helpful!
Laz